A subsidy causes deadweight loss:
A) only because of inefficient increases in trade.
B) only because of unexploited gains from trade.
C) because of both inefficient increases in trade and the unexploited gains from trade.
D) only if the supply of the good being subsidized is unit elastic.

Question

Quizplus · Accepted Answer

A subsidy causes deadweight loss because it creates both inefficient increases in trade and unexploited gains from trade. The subsidy leads to an overproduction of the subsidized good and a reduction in production of other goods that would have been more efficiently produced. Additionally, the subsidy encourages consumers to buy more of the subsidized good, even if they would have preferred to buy other goods at the market price. Both of these effects lead to a loss of economic efficiency and a reduction in total surplus. The elasticity of supply is not directly related to the deadweight loss caused by a subsidy.

A Subsidy Causes Deadweight Loss