This example is for my book. Does it make sense?
And ﬁnally, we get to an important, invisible subsidy – the subsidy for preferential access. Say that you and 5,000 other people want to go to a concert that’s in a hall with a capacity of 800 people. Tickets are only $5, but how do you get a ticket? If there was an open market for tickets, buyers might compete to push the price to $50, but there isn’t. Only some people — the connected, cool folks — are going to get tickets. (I’ll get to reselling tickets in a bit.) Note that the ticket promoter is forgoing $45 per ticket to distribute it to the cool people. We don’t know why he’s willing to pay this opportunity cost, but he is.
Let’s break down this example. Some cool people would have bought the ticket at the full price. Andy, for example, pays $5 for a $50 ticket that he values at $65, so he gets a subsidy ($45 = $50–$5) on top of his benefit ($65 less $50). Other cool people are going to get the $5 tickets that they would not have bought for $50. Bob is cool, but he’s only willing to pay $35 for the ticket. Bob gets a positive value of $30 ($35-$5) from the difference between what he pays and his value, but the remaining $15 of the $45 subsidy is wasted, as a deadweight loss from the difference between the ticket’s value in an open market and Bob’s value. But there’s more, there’s the deadweight loss from Carl not being able to buy that ticket. Carl values the ticket at $75 and would have been happy to pay $50 for it. From a social perspective, this method of distributing tickets creates deadweight losses from tickets ending up in the wrong hands. The $40 deadweight loss is the sum of the foregone benefit when Carl did not get the ticket ($75 less the $50 market price) plus the difference between the market price and Bob’s value ($50 less $35). It also creates subsidies by selling the ticket below the market price ($45 to Adam and $30 to Bob). Although the subsidy is merely a transfer of wealth from the ticket seller (money foregone), it’s valuable to those cool people who get that transfer. The deadweight loss is not valuable to those with preferential access – the cool people – but they are socially costly as a misallocation of resources.
If a secondary market was allowed to function, then we’d expect that Bob would sell his ticket to Carl. If he sold it for $60, then deadweight loss would go to zero.* Although that sale would not reduce the cost of the subsidy ($45 per ticket), it would change its value. The subsidy was only worth $30 to Bob, but now it’s worth $55. So now you have a better understanding of why people like subsidies. First, because they get something for less than cost – and sometimes less than their value. Second, because they can sell subsidized goods to others without preferential access. This ticket example demonstrates how preferential access wastefully misallocates valuable assets. Although it would be better to end such practices, a second-best choice – allowing re-selling – can eliminate most of the waste. Reselling is also more feasible, since winners in the current system would continue to win.
This gets us to water rights and access to infrastructure...
* This is slightly tricky, since deadweight loss is defined as the difference in values when the ticket ends up in the wrong hands ($40), not as the distribution of benefits ($15 to Carl and $25 to Bob) from reallocating that ticket.