Discuss the extent to which a subsidy given to producers might encourage an increase in the

consumption of a product such as puer tea which generates positive externalities.

A subsidy allows the tea producer to reduce their costs and induces them to supply more output of
tea at any given price.
[Diagram here]
As the above diagram shows at any given price the tea producer is inclined to produce more tea.
Without the subsidy, market equilibrium is its price P1 and quantity is Q1. With the subsidy in place,
the equilibrium price falls to P2 and the quantity to Q2. Furthermore the surplus for both consumer
and producer will increase as producers sell more and consumers can buy at lower prices.
As illustrated in the diagram the degree of success of the subsidy also depends of the elasticity of
demand. If the price falls by less than the amount of the subsidy benefits would be shared between
the producers and the consumers.
The subsidy will produce an incentive for the tea producer to reduce the price of tea which produces
positive externalities including
-Allowing more poor people to buy tea
-External benefits to productivity such as jobs
Some of the externalities will be in the hands of the tea producers. If producers pass on the subsidy
benefits or not will determine the success because if they do not then some people might still not be
able to buy tea.
Government policies are the key for subsidies success. It is important to understand what the
government is trying to achieve for example if the idea is to increase production to create more jobs
or if the idea is to produce more tea at a lower price to allow lower waged people with less
disposable income to buy tea.
The subsidy may be to cover supply fluctuations with the aim of making sure the same amounts of
tea are produced in all seasons. Furthermore the positive externalities will come from many
different sources including lower price, higher employment and maybe even higher taxes for the
government.
To conclude the extent to which a subsidy will increase consumption depends on both the producers
who have to choose to hand the benefits over and governments as it will depend on how much they
give the producer to what effect it may cause.