Explain the effect of a subsidy on equilibrium price and quantity in a demand and supply model.

If the government offer a subsidy to firms, this will reduce their per unit cost of production. This will shift supply downwards, as for a given market price, the firm is willing to produce more. This will reduce the prices in equilibrium and increase the quantity produced. The distance between the two curves is the value of the subsidy. The magnitude of the change in price and quantity will depend on the elasticity of demand. If demand is relatively price elastic, then an introduction of a subsidy will cause a relatively large increase in quantity but a relatively small decrease in price. However, if the demand is price inelastic, the change in price will be relatively large compared to the change in quantity.