Economics – Utility | e-Consult

A subsidy on renewable energy effectively lowers the price of renewable energy for consumers. According to the equi-marginal principle, consumers will increase their consumption of renewable energy until the marginal utility per pound spent on renewable energy equals the marginal utility per pound spent on other goods.

Consumer Impact: The subsidy makes renewable energy more attractive relative to other goods. Consumers will substitute away from less desirable energy sources (e.g., fossil fuels) and towards renewable energy. This is because the effective price of renewable energy has decreased, making it a more appealing use of their income. The increased consumption of renewable energy will lead to a higher overall utility for the consumer.

Producer Impact: The subsidy increases demand for renewable energy, leading to higher profits for renewable energy producers. This increased profitability incentivizes producers to increase their output. The higher demand may also lead to investment in new renewable energy technologies and infrastructure. The producer will adjust their production levels to maximize their profit, taking into account the subsidy and the changing demand curve.

Resource Allocation: The subsidy encourages a shift in resources away from fossil fuels and towards renewable energy. This leads to a more efficient allocation of resources, as resources are directed towards the energy source that provides the greatest overall benefit to society (considering both consumer utility and environmental benefits). The subsidy helps to internalize the external costs associated with fossil fuels (e.g., pollution).