A subsidy shifts supply downward or demand upward, increasing output.

• A. Shifts demand downward and reduces output
• B. Shifts supply downward or demand upward, increasing output
• C. Shifts supply upward and reduces output
• D. Has no effect on market output

Answer: (B)

A subsidy makes it cheaper or more attractive to produce or buy goods, so it changes incentives in the market. If a subsidy goes to producers, their cost per unit falls, shifting the supply curve downward (to the right). If a subsidy goes to buyers, their purchasing power rises, shifting the demand curve upward. In either case, the market reaches a new equilibrium with a larger quantity traded, so output increases. The other possibilities would involve reduced demand or reduced supply, which isn’t what a subsidy does. Depending on who receives the subsidy, the price to consumers may fall or rise, but the key effect is higher output.