Management Notes

Reference Notes for Management

If the home country government grants a subsidy on a domestically produced good domestic producers tend to:

If the home country government grants a subsidy on a domestically produced good domestic producers tend to:

 Options:

a. capture the entire subsidy in the form of higher profits
b. increase their level of production
c. reduce wages paid to domestic workers
d. consider the subsidy as an increase in production cost

The Correct Answer Is:

b. increase their level of production

Effects of Government Subsidies on Domestic Producers:

When a home country government grants a subsidy on a domestically produced good, it has various implications for domestic producers. This subsidy acts as a financial incentive intended to benefit local industries and stimulate economic growth.

In this context, the correct option is (b) domestic producers tend to increase their level of production. This choice aligns with economic theory and empirical evidence, as it reflects the expected response of producers to a subsidy.

Explanation of Correct Answer :b. increase their level of production

When a government provides a subsidy on domestically produced goods, it effectively reduces the production costs for domestic producers. This means that producers can now produce goods at a lower cost compared to before the subsidy was introduced.

As a result, producers are incentivized to increase their level of production. With lower costs, they can either maintain the same price and enjoy higher profit margins or reduce prices to compete more aggressively in the market. In either case, an increase in production is a logical response to the subsidy.

Furthermore, an increase in production may lead to economies of scale, which can further reduce production costs. This can create a positive feedback loop, encouraging producers to expand their operations even further.

Additionally, increased production can stimulate economic activity by creating more jobs, thereby boosting employment levels in the domestic market.

Explanation of Incorrect Answers:

a. Capture the entire subsidy in the form of higher profits:

While domestic producers will indeed experience higher profits due to reduced production costs, it is unlikely that they will be able to capture the entire subsidy.

Competition in the market may force producers to pass on some of the benefits to consumers in the form of lower prices, especially if the subsidy leads to increased production and supply.

c. Reduce wages paid to domestic workers:

The introduction of a subsidy is not directly linked to reductions in wages. In fact, if production increases, it may lead to a higher demand for labor, potentially resulting in higher wages. The subsidy is aimed at reducing production costs, not labor costs.

In fact, if production increases due to the subsidy, it may lead to a higher demand for labor, potentially resulting in higher wages for domestic worker

d. Consider the subsidy as an increase in production cost:

This option is incorrect as a subsidy is designed to lower production costs, not increase them. Domestic producers will view the subsidy as a financial benefit that enables them to produce goods at a lower cost, thus improving their competitive position in the market.

In conclusion, when a home country government provides a subsidy on domestically produced goods, domestic producers are likely to respond by increasing their level of production. This is because the subsidy reduces production costs, providing an economic incentive to produce more.

While producers will indeed experience higher profits, capturing the entire subsidy in the form of profits may not always be feasible due to market competition. The subsidy’s primary impact is on production costs, not wages, and it is not considered an increase in production cost.

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