In which of the following scenarios will a subsidy increase consumption the most?

• A. When supply is perfectly inelastic
• B. When supply is highly elastic
• C. When demand is perfectly inelastic
• D. When demand is highly elastic

Answer: (D)

Verified step by step guidance

1. Understand the concept of elasticity: Elasticity measures how much quantity demanded or supplied responds to changes in price. Demand elasticity refers to how sensitive consumers are to price changes, while supply elasticity refers to how sensitive producers are to price changes.
2. Recall the effect of a subsidy: A subsidy effectively lowers the price paid by consumers or increases the price received by producers, encouraging more consumption and/or production.
3. Analyze the impact of a subsidy when demand is perfectly inelastic: Since quantity demanded does not change with price, a subsidy will not increase consumption much because consumers buy the same amount regardless of price.
4. Analyze the impact of a subsidy when demand is highly elastic: Consumers are very responsive to price changes, so a subsidy that lowers the effective price will lead to a large increase in quantity demanded, thus increasing consumption the most.
5. Compare supply elasticities: While supply elasticity affects how much producers respond to price changes, the question focuses on consumption, which depends primarily on demand elasticity. Therefore, a subsidy increases consumption the most when demand is highly elastic.