The Benefits of an Electric Car Subsidy

What is a subsidy? A subsidy is a government grant to firms in the hope that firms will reduce the price and increase the quality/quantity of a good or service. In March 2021, the maximum grant for electric cars was reduced from £3,000 to £2,500 and the government also lowered the price cap for cars eligible for the subsidy from £50,000 to £35,000. In this article, I will be discussing the extensive benefits of the increased subsidisation of electric cars in the UK.

In today's society, electric cars are under-consumed and under-produced. This is represented by equilibrium B, where marginal private benefit is equal to the marginal private cost (here, marginal social cost is also greater than the marginal social benefit). We can also see that Q2 is the socially optimum, as all private and external costs are accounted for, resulting in greater consumption of electric cars. The subsidy (if implemented correctly), which is the vertical distance CD, corrects market failure and lowers the price of the good from P1 to P2. This will mean the welfare loss area decreases from ABC to no area, as the subsidy means there is greater consumption of electric cars. As electric cars are just battery powered, this will mean carbon dioxide emissions are reduced, thus reducing the degradation of the environment, as there is less air pollution. This will inevitably reduce air pollution related illnesses (such illnesses currently cost the NHS £157 million and it may cost up to £18.6 billion in 2035), which will mean strain on the NHS is reduced. This will mean the NHS has greater resources to treat other life-threatening diseases, like HIV or cancer.

Currently in Japan, there is a 800,00 yen subsidy for electric car companies, which has proved to be fairly ineffective, as sales of electric vehicles in Japan came to slightly below 15,000 units, representing less than 1% of overall new vehicle sales in the country. If the subsidy is of the correct magnitude, it should decrease the cost of production of electric vehicles. This will cause the supply of electric cars to shift outwards, causing quantity to increase from Q1 to Q2 and causing price to decrease from P1 to P2. As a result, demand extends from A to B. This means that revenue for electric car manufacturers increases from P1,A,Q1,0 to P3,C,Q2,0, causing producer surplus to increase from P1,A,0 to P3,C,B,Q1,0. As a result, there will be increased investment (better infrastructure for electric cars) and research in the electric car industry. This will mean there is greater employment in this industry, as manufacturers will have a greater incentive to produce more cars due to the increase in revenue. This may result in a greater scale of production for manufacturers, thus causing the average cost per unit to fall. This will cause a further increase in sales (greater output of electric cars), which will increase profits for electric car companies.

In conclusion, the benefits of an electric car subsidy are extremely significant, as it may result in increased employment in this industry and, more importantly, it will reduce pollution, which will reduce the strain on NHS as there will be less air pollution related illnesses. To make this more effective, the subsidy can be used in combination with an indirect tax on petrol/diesel cars to decrease carbon dioxide/pollution levels and to further stimulate the sales of electric cars.