2020 IB Extended Essays

production and profit level. Figure 1.1 below shows what happens economically when a subsidy is

introduced into a market. As Figure 1.1 demonstrates when the subsidy of $100 per kW of solar

panel is introduced, it shifts the supply curve down by $100 (S1 to S1 + subsidy). Triangles 1 and 2 in

the diagram below demonstrate the welfare loss that occurs when a subsidy is introduced. This

welfare loss is a repercussion of introducing a subsidy and is caused because the socially optimal

quantity of 400 solar panels. The welfare loss in the diagram below is the sum of triangles 1 and 2

which is:

Calculation 1.1 Welfare loss calculations Triangle 1 = 1 2 × × ℎ Triangle 1 = 0.5 × 100 × 100 Triangle 1 = 5000

Triangle 2 = 1 2 × × ℎ Triangle 2 = 0.5 × 100 × 100 Triangle 2 = 5000

Welfare Loss = Triangle 1 + Triangle 2 = 10,000

Consumer surplus and producer surplus can also be calculated by the graph below. Consumer

surplus is the difference between the price that the consumer wants to pay and is required to pay

for the solar panels. It is a way to easily show the benefit to the consumer of the product.

Consumers surplus is shown by the gray shaded area. The consumer surplus is calculated by the area of the shaded box which is 100 × 500 = $50000. This means that consumers will save $50,000 with the subsidy, at an output of 500 units with a price of $500 per kW of solar panels installed. Producer surplus is the same, except it is the dark gray rectangle, and is calculated to be 100 × 500 = $50000 . This means that producers also save $50,000 due to the subsidy.

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