IBEconomicsHLRevision Notes4. The Global Economy4.2 Types of Trade Protection4.2.3 Export Subsidies

Export Subsidies (HL IB Economics)

Revision Note

Steve Vorster

Expertise

Economics & Business Subject Lead

An Explanation of Export Subsidies

  • Both subsidies and export subsidies lower the cost of production for domestic firms 

    • They can increase output and lower prices

    • With lower prices their goods/services are more competitive internationally

    • If firms are able to meet all of the domestic demand (Dd) then the excess supply may be exported

    • Otherwise, the level of imports will decrease

    • The increased output may result in increased domestic employment
       

  • Following the 2nd World War, the European Union subsidised food production and this has continued ever since

    • Once food security had been established within Europe, countries were able to start exporting the excess supply that subsidies generate
       

4-2-3-export-subsidies

European Union subsidies for truffle producers shift the domestic supply curve to the right which decreases the level of truffle imports required from Q1Q3to Q2Q3
 

Diagram Analysis

  • The domestic market for truffles in the EU was initially in equilibrium at PwQ3

    • Domestic firms supplied up to Q1, while Q2-Q1 was imported into the EU
       

  • The implementation of the subsidy lowered firms costs of production, shifting the domestic supply curve from Sd to Sd + subsidy

    • Domestic firms increase output and market share from Q1→Q2

    • Imports reduce from Q1Q3 → Q2Q3

An Evaluation of Subsidies

  • An evaluation of the effectiveness of the use of subsidies as a form of protectionism is best done by considering the impact on all of the relevant stakeholders
     

4-2-3-an-evaluation-of-subsidies

The effect on different stakeholders can be considered by analysing each area of the international subsidy diagram
 

  • The stakeholders affected are domestic and foreign producers, consumers, government, and society (welfare)
     

An Evaluation of the use of Subsidies to Protect Domestic Firms


Stakeholder


Explanation

Domestic Producers

  • Decreases costs of production

  • Increases output from Q1 → Q2

  • Revenue before subsidy was f+g

  • Revenue after subsidy is b+c+f+g+h

  • Increases international competitiveness

Foreign Producers

  • Makes it harder for them to compete with domestic firms

  • Their exports reduce from Q3-Q1 →  Q3-Q2

  • Revenue for foreign firms before the subsidy was h+i

  • Revenue after the subsidy is only i

Consumers

  • Consumers already benefitted from the lower world price and receive no further benefit

Government

  • This costs the government the amount of the subsidy - area b+c

  • There is an opportunity cost associated with every subsidy provided

Society (Welfare)

  • There is a welfare loss (area c) as more inefficient domestic producers are now producing at the expense of more efficient global producers

Worked Example

The diagram below illustrates the EU truffle market. Due to domestic pressures, the EU implemented a subsidy to truffle farmers. SD is EU domestic supply, DD is EU domestic demand, Sw is world supply and Ssubsidy is domestic supply with the tariff.

ibdp-economics---calculating-the-impact-of-subsidies-on-trade

Answer:

Using information from the diagram

a) Calculate the cost of the subsidy to the government [2]

Step 1 - Identify the size of the subsidy and the quantity domestic producers supply with the subsidy

Size of subsidy = €10 per unit

Domestic producer supply = 15m Kg's
 

Step 2 - Calculate the subsidy spend by government

Total subsidy = €10 x 15m Kg's

Total subsidy = €150m

[1 mark for any correct working and 1 mark for correct answer]

 

b) Calculate the change to the quantity of imports [2]

Step 1 - Identify & calculate the original level of imports

= (30m kg's - 5m kg's)

= 25m kg's
 

Step 2 - Identify & calculate the new level of imports

= (30m kg's - 15m kg's)

= 15m kg's
 

Step 3 - Calculate the difference

= (25m kg's - 15m kg's)

= 10m kg's

The level of truffle imports has fallen by 10m kg's

[1 mark for any correct working and 1 mark for correct answer]

 

c) Calculate the change to domestic producer revenue as a result of the subsidy [2]

Step 1 - Identify & calculate the original level of domestic producer revenue

= €10 x 5m kg's

= €50m 
 

Step 2 - Identify & calculate the new level of domestic producer revenue

= €20 x 15m kg's

= €300m

Step 3 - Calculate the difference

= €300m - €50m

= €250m

Domestic producer revenue has increased by €250m

[1 mark for any correct working and 1 mark for correct answer]

Exam Tip

When evaluating the use of subsidies in essay responses, it is worthwhile considering both the length of time that the subsidy has been in place, along with the size of the subsidy.

If the subsidy is large and has been in place for a long time, the industry is likely to be a global monopoly such as the USA cotton industry. Their price is effectively the world price.

This is one reason why the WTO aims to limit export subsidies. They put small-scale farmers in developing nations out of business, often decimating the industry and thus increasing unemployment. Compared to fifty years ago, very few African countries now produce cotton. This is entirely down to the size and longevity of the subsidies in the USA.

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    Steve Vorster

    Author: Steve Vorster

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.