Supply shifts down by the subsidy: who gains, what it costs the government, the welfare loss, and whether a subsidy is worth it.
In July 2025 the government launched the Electric Car Grant, with £650 million to spend. It takes up to £3,750 off a new electric car priced at £37,000 or less, applied at the dealer, with £1,500 for cars whose production is judged less green. In the November 2025 Budget it got another £1.3 billion and was extended to 2030.
The grant is paid through the car makers. So who really gets the £3,750: buyers or car firms? And is it worth £2 billion?
Sources: Department for Transport (July 2025); HM Treasury, Autumn Budget 2025.
A subsidy is a payment from the government to producers that lowers their costs. A per-unit subsidy pays a fixed amount for each unit sold, like the car grant. It is the opposite of a specific tax.
Governments subsidise goods to increase consumption of goods that benefit society, such as public transport, vaccines or green technology, to keep prices down for consumers, and to support jobs in an industry.
The model assumes a competitive market with normal supply and demand curves, and that only the subsidy changes (ceteris paribus).
The government pays car firms £3,750 for every cheap electric car sold.
Before the grant, an electric car sold for £33,000.
What is the most likely new price to buyers?
The price falls, but usually by less than the subsidy. Part of the grant goes to buyers in a lower price and part goes to car firms in a higher price received. It is the tax lesson in reverse.
The market before the subsidy: P1 and Q1.
The government pays firms £3 for every unit. To supply any quantity, firms now need £3 less from the buyer, because the government pays the rest. So supply shifts vertically down by the subsidy, parallel to S. Supply has increased: more is supplied at every price.
Check: A £3 per-unit subsidy is paid to producers. Which way does supply shift?
For any quantity, firms now need £3 less from the buyer, because the government pays the other £3. So supply shifts vertically down by the subsidy, in parallel.
The new equilibrium is where the new supply curve crosses demand. The price consumers pay falls from £6 to P2, £4, and the quantity rises from Q1 to Q2. The price fell by £2, not the full £3.
Producers get £4 from the buyer and £3 from the government: £7 in total. Read it off the original supply curve straight above Q2. That point is on S because £7 is what firms need to supply Q2.
Check: Consumers pay £4. What do producers receive for each unit, including the subsidy?
Producers get £4 from the buyer plus £3 from the government: £7, more than the £6 they got before.
The cost to the government is the subsidy per unit times the quantity sold after the subsidy: £3 × Q2. It is the rectangle between P2 + subsidy and P2, out to Q2. Use Q2, not Q1: the subsidy is paid on every unit now sold, including the extra ones.
Split the cost at the old price, P1. Below P1 is the consumers’ gain: £2 a unit. Above P1 is the producers’ gain: £1 a unit. As with a tax, the more inelastic side gets more: here demand is steeper than supply, so consumers get most of the subsidy.
Check: Who gains more from this subsidy?
Consumers pay £4 instead of £6: £2 better off. Producers receive £7 instead of £6: £1 better off. The subsidy is paid to producers, but consumers get most of the benefit here.
The subsidy also changes how many units are traded.
Check: Between Q1 and Q2, the original supply curve is above demand. What does that tell you about those extra units?
Supply shows the cost of making each unit and demand shows what buyers value it at. Where supply is above demand, each extra unit costs more than it is worth, so welfare is lost.
One more area. The extra units between Q1 and Q2 cost more to make than buyers value them at: supply is above demand there. So in this simple diagram, the subsidy creates a welfare loss, the triangle. Unless the good has benefits that buyers do not count, which is exactly why governments subsidise.
Now think about what the grant actually buys.
Check: The Electric Car Grant is paid on every eligible new electric car sold. Why might much of the money change nothing?
Buyers who would have bought an electric car anyway still get the grant, so that part of the money buys no extra electric cars. It still has an opportunity cost.
So is a subsidy worth it? Weigh the gains against the costs.
Their rectangle stops at Q1. The subsidy is paid on every unit sold after it, so the cost goes out to Q2. Their price received is also read at Q1, not straight above Q2.
Explain, using a diagram, the effect of a per-unit subsidy on electric cars on consumers and producers.
A subsidy is a payment from the government to producers for each unit sold, which lowers their costs. The Electric Car Grant takes up to £3,750 off each eligible new electric car.
[Diagram: D and S crossing at P1 and Q1. S + subsidy parallel to S, below it by the subsidy. New equilibrium at P2 and Q2. P2 + subsidy read off S above Q2. The cost rectangle between the two prices, out to Q2.]
The subsidy lowers the cost of supplying each car by the same amount, so supply shifts vertically down by the subsidy. At the old price there is now excess supply, so the price buyers pay falls from P1 to P2 and the quantity bought extends from Q1 to Q2.
The price falls by less than the subsidy. Consumers gain because they pay P2 instead of P1. Producers gain because they receive P2 plus the subsidy, which is more than P1, and sell more cars. The government pays the subsidy on every car sold, Q2. How the gain is split depends on elasticity: if supply of cheap electric cars is inelastic, more of the grant goes to car firms.
Electric Car Grant: Department for Transport (July 2025) and Autumn Budget 2025. Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed. Your answers are saved only on this device.