Why doesn't the government subsidize firms on the condition that they lower prices?

Question

Lets pretend that all production is contingent on fixed cost capital, the good or service made from this capital is sold at a price that means that demand is below what the capital has the capacity to produce, lets say we have a theatre with 10 seats and the market price is \$2 which puts demand at 5 units. By lowering price the demand for the service increases which partially off sets the revenue lost from lowering price, lets say lowering the price to \$1 increased demand to 9 units. Here the seller has gone from making 10 dollars from selling 5 units for \$2 each, to making \$9 from selling 9 units for \$1 each. The seller has lost \$1 for lowering price, but the buyers have made approximately \$7. Since the 5 buyers who would've bought for \$2 now pay \$1 saving \$5 collectively. And the 4 new buyers, who value the product somewhere between 1-2 dollars would have valued it on average 1.5 dollars which makes them a 5o cent surplus each, or \$2 collectively.

So if the government pays the cinema to lower prices to \$1, they spent \$1 but increased the buyers consumer surplus by 7\$. This is a solution for the underutilization of capital that we see in the free market, empty seats on buses and trains, empty roads, empty theatres, empty stadiums, games unplayed, films unwatched, online courses unlearnt from, medicinal and technological innovations unused, etc.

Even when the production process isn't very capital intensive that need to profiteer off of the fixed capital makes the price arbitrarily high which scares away consumption.

Answer 1

First, some of your arguments are off. The price is not arbitrary high as it still depends on demand. Its not like they could charge billion dollars per ticket if maximum willingness to pay of any consumer is let's say \$10.

Next;

This is a solution for the underutilization of capital that we see in the free market, empty seats on buses and trains, empty roads, empty theatres, empty stadiums, games unplayed, films unwatched, online courses unlearnt from, medicinal and technological innovations unused, etc.

This observation is actually not completely correct. These are not necessarily underutilized because of fixed capital cost.

• Fixed capital costs are sunk ex post. Over long-run firm has to recoup them but they do not necessarily determine intratemporal short-run decisions. For example, game development has high fixed costs but very low marginal costs, so usually you see high price when the game is new and people with highest willingness to pay don't have the game, but over time the price goes down to be closer in line with marginal costs.

• Some seats are empty just because it is impossible to predict demand. Demand can only be either estimated or guessed in advance. So you can't simply in real life say that when price \$2 per ticket exactly 5 people show up. Depending on uncertainty perhaps just 3 people would show up or 8.

  This is for example why in areas where it is very important to fill each seat, such as on airplanes, overbooking occurs. If demand would be certain there would be never a need for such practice.

• Some empty seats are actually direct result of government subsidies. Most governments around the world subsidize public transport or subsidize culture etc. This is usually done due to some normative reasons such as support of art that most people don't appreciate, or equity reasons to give transport options to some smaller and unimportant towns. Such subsidies are typically paid per route or theatre etc. This often result nearly empty busses or trains on some routes, or nearly empty plays of contemporary art show.

So you can't just immediately jump to conclusion just because you anecdotally see empty bus or theater.

As a consequence,

In real life:

1. it is difficult to see if a capital is underutilized. This requires rigorous research that would have to be done for the same unit of capital periodically.

2. it is difficult to know what a demand is, so it is difficult to know what lump-sum subsidy has to be offered. Demand can be estimated, but demand changes across time so this would again have to be done periodically.

3. Even with the best and most precised state of art method there will always be uncertainty about those estimates.

4. as a consequence of 1 or 2 and 3, but primarily 3, there would have to be periodic negotiations between government and firms on this lump sum. This would incur further transaction cost.

For example, in US there must be thousands of theaters, and it would be very difficult to do 1-4 for all of them. There probably are not even enough experts to do just 1 or 2 for them.

Answer 2

A quote from your comment...

For starters its not the taxpayers per se who who decide government policy, but voters, and voting is an inherently selfless act and so you'd expect them to care about social-welfare, this is because the expected personal benefits of voting are outweighed by the expected personal costs, as its really unlikely that your vote will matter, meaning that you'd only want to vote if you cared that the social benefit was greater than the personal costs, which they are because they affect millions, instead of one, person.

If social welfare increases for one cinema for one showing, then the same motivation would require every cinema and every bus and every toll road to be subsidized at all times.

When ubiquitous subsidies happen, it becomes apparent that everybody would be taxed significantly more and partaking in significantly more activities that utilize capital investments while experiencing significantly more consumer surplus. This economy would have the government deciding the right subsidy for every showing in every cinema and every flight for every airplane. The individual cedes control over some of the spending in the economy. This problem is worsened in the ubiquitous subsidy economy.

You need to demonstrate that incremental loss of control about how to spend money results in very little or no general welfare reduction.

Addendum... (Too long for a comment)...

You wrote a lot of comments but you completely missed my point. Loss of control. You did not mention it. Loss of control means you need a substitute mechanism for individual preferences to be incorporated into decision making. How can resources (like the inputs to create and operate the right number of cinemas and the right quality and amount of internet infrastructure for streaming movies) be allocated to maximize welfare under your system? When individual choices are changed by government incentives, how can the many subsidies be sized properly to boost welfare? "Individual choices are changed" could equally be expressed as "individual choices are distorted" compared to what they would otherwise be in the pre-subsidy world. My presumption is that the government is not omniscient so I think welfare will be less compared to the pre-subsidy world when individual spending determined which businesses closed and which expanded. Loss of individual control necessitates government omniscience or else there is a decrease in general welfare is my default presumption. My claim is that the government is not omniscient so there will be a reduction in general welfare.