To what extent do subsidies might encourage the consumption of a good that generates positive externalities such as pu’er tea? A positive externality occurs when a benefit accrues to someone outside of the production or consumption of a good. Goods which contain significant positive externalities are known as merit goods. However, without intervention these goods and services do not respond well to price signals and would be under consumed at market price, because they are expensive and not wanted at all times. In order to fix this market failure government introduce many policies to encourage consumers to buy these goods. One of the main methods they use is subsidies. The aim of a subsidy is to reduce the private marginal cost (PMC) of consuming a good. A subsidy would provide an incentive for more people to consume merit goods and take us closer to the socially optimal level of output is achieved.
By introducing subsidies to a market governments help encourage the consumption of merit goods. By helping to subsidise suppliers there is a shift right in supply as illustrated by the graph causing the price to drop for consumers. This helps to raise the real incomes for buyers meaning that they will be in a position to consumer more merit goods and demand for goods such as pu’er tea will increase. If the consumption of pu’er tea increases then it is likely that as pu’er tea helps to reduce cholesterol then there will be a deduction in the number of heart attacks and as such hospital bills will decrease. The subsidies also help to maintain or increase the revenue of producers. This keeps businesses afloat and workers employed which is partially important in a time of recession when there are high unemployment levels. Higher employment rates mean that consumers on average are more affluent and will be able to buy merit goods. However, there are problems associated with subsidies. Firstly, as with pollution tax it is difficult to set a precise value for the...
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