A profit-maximizing dairy farm is currently producing 10,000 gallons of milk per day.The government is considering two alternative policies.One is to give the farm a lump sum subsidy of $500 per month.The other policy is to give the farm a subsidy of $.05 per gallon of output.
A)Both kinds of subsidy will increase production at this farm.
B)Neither subsidy will affect production at this farm, since output is determined by profit maximization.
C)Production at this farm will be increased if the per-unit subsidy is adopted but not if the lump sum subsidy is adopted.
D)Which subsidy has the greater effect on production at this farm depends on whether fixed costs are greater than variable costs.
E)Production will be increased by either kind of subsidy if and only if there are not decreasing returns to scale.

Question

Quizplus · Accepted Answer

A per-unit subsidy will increase the farm's incentive to produce more milk, since the subsidy is tied to each gallon produced. The farm can increase its revenue by producing more milk, even if the per-unit profit is small. However, a lump sum subsidy does not depend on production, so the farm has less incentive to increase output.

A Profit-Maximizing Dairy Farm Is Currently Producing 10,000 Gallons of Milk