The government of Kelmara wants to increase consumption of reusable water-filter cartridges, a merit good that reduces households' reliance on single-use bottled water. It introduces a subsidy of $0.75 per cartridge sold to manufacturers. Before the subsidy, 40 000 cartridges we…

Answer: ((a)) A subsidy is a payment made by the government to producers, which lowers their cost of supplying a good, encouraging them to produce and sell more of it at a lower price to consumers. ((b)) $41 250 per month ($0.75 per cartridge x 55 000 cartridges sold once the subsidy is in effect). ((c)) Advantage: a subsidy keeps consumer choice intact and directly lowers the price households pay, making the merit good more affordable without banning any alternative. Disadvantage: the subsidy has an opportunity cost to government funds (here, $41 250 every month that could have…. Part (a): Defining a subsidy A subsidy is a payment made by the government to producers, which lowers their cost of supplying a good. Because it becomes cheaper for manufacturers to make and sell the good, they are willing to supply more o…

IGCSE Economics 0455: Calculating the Cost of a Subsidy on a Merit Good

Part (a): Defining a subsidy

A subsidy is a payment made by the government to producers, which lowers their cost of supplying a good. Because it becomes cheaper for manufacturers to make and sell the good, they are willing to supply more of it at a lower price, which raises the quantity that consumers buy.

Part (b): Calculating the total monthly cost of the subsidy

The government pays the subsidy on every cartridge sold once it is in effect, so the total monthly cost is the subsidy per cartridge multiplied by the number of cartridges sold after the subsidy has taken effect. That is 55 000, not the original 40 000.

$\text{total monthly cost} = \$0.75 \times 55\,000 = \$41\,250$

So the subsidy costs the Kelmaran government $41 250 per month.

Part (c): Subsidy versus direct provision

Advantage of a subsidy: households keep the freedom to choose whether and where to buy a cartridge, while the subsidy makes the good cheaper for everyone, this directly narrows the gap between the private benefit consumers perceive and the wider social benefit of reduced plastic-bottle waste, without the government needing to manufacture or distribute anything itself.

Disadvantage of a subsidy: the $41 250 spent each month is an opportunity cost. Those funds could instead have gone toward, for example, expanding piped water access, which might raise the merit good’s consumption more directly. There is also a risk that manufacturers respond to the subsidy by raising their pre-subsidy price, meaning some of the $0.75 per cartridge ends up as extra profit for producers rather than being passed on fully as a lower price for households, weakening the intended effect on consumption.

Final answers

(a) A subsidy is a government payment to producers that lowers their cost of supply, leading to more of the good being produced and sold at a lower price.
(b) Total monthly cost of the subsidy = $41 250.
(c) Advantage: preserves consumer choice while lowering price and narrowing the gap to social benefit. Disadvantage: opportunity cost of government spending, and producers may capture part of the subsidy through a higher pre-subsidy price.