Subsidies in a Competitive Market

A per-unit subsidy works like a tax in reverse. The government pays sellers a fixed amount for every unit sold, so sellers are willing to supply any given quantity at a lower price than before. On a graph, supply shifts down (or right) by exactly the subsidy amount. The new equilibrium quantity is higher than the original one, because the effective price sellers receive is now the price buyers pay plus the subsidy.

That extra money gets split between buyers and sellers, and the split depends on elasticity. Whichever side is less elastic, less able to walk away from the trade, captures more of the subsidy's value. That is why a subsidy to solar panel makers does not cut the buyer's price by the full subsidy: sellers keep part of the gain as higher revenue per unit, and buyers get the rest as a lower price. Only in the extreme case of a perfectly elastic side does one party capture the whole benefit.

This connects directly to taxes and price controls, the other tools in this unit. A tax shrinks the gap between what buyers pay and sellers receive; a subsidy widens it. Both move quantity away from the free-market equilibrium, but a subsidy pushes quantity up past the efficient level instead of down below it. Once quantity rises past where marginal benefit equals marginal cost, each extra unit costs more to produce than buyers value it, so total surplus falls even though trade volume rises, and the government pays for every unit, efficient or not.