The government passes a law that allows a substantial subsidy for every acre of land use to grow tobacco. How does this program affect the long- run supply curve of tobacco?
The correct answer and explanation is :
Correct Answer:
The government subsidy increases profitability for tobacco production, which causes the long-run supply curve of tobacco to shift to the right (i.e., increase in supply).
Explanation (300 words):
In the long run, firms respond to changes in profitability by entering or exiting an industry. A government subsidy for every acre of land used to grow tobacco effectively lowers the cost of production and increases potential profit for farmers and firms in the tobacco industry.
When such a subsidy is introduced, existing producers find tobacco farming more attractive, as the subsidy boosts their revenue per acre regardless of market price. As a result, current tobacco farmers may expand their operations by utilizing more land or investing in more efficient production methods.
Moreover, the higher profitability due to the subsidy attracts new entrants into the market. Farmers who previously grew other crops or were not engaged in agriculture may begin cultivating tobacco to take advantage of the government payments. This entry of new producers into the market increases the total quantity of tobacco supplied at every price level.
In economic terms, this results in a rightward shift of the long-run supply curve for tobacco. The long-run supply curve represents the relationship between price and quantity supplied when all inputs are variable and firms can enter or exit freely. Since the subsidy makes the industry more attractive, more producers join over time, and supply increases.
It is important to note that this shift reflects a change in supply, not a change in quantity supplied. A change in quantity supplied would be a movement along the supply curve due to a change in price. However, a subsidy alters the underlying economic conditions and incentives, shifting the entire supply curve.
In conclusion, a per-acre subsidy for tobacco production increases the profitability of growing tobacco, attracting more resources into the industry and causing the long-run supply curve to shift to the right. This results in greater production of tobacco in the long term at any given market price.