Explanation

An export subsidy is a government payment to domestic producers for each unit of a good exported. In a small country context (where the country is a price-taker in world markets), the analysis is as follows:

1. Without subsidy: Domestic price equals world price (Pw). At this price:

   • Domestic production = Q1
   • Domestic consumption = C1
   • Exports = Q1 - C1

2. With export subsidy: The subsidy effectively increases the price received by domestic producers for exported goods. Producers now receive Pw + subsidy for exports.

3. Impact on domestic market:

   • Producers will want to sell more at the higher effective price
   • To export more, they need to divert supply from domestic to foreign markets
   • This creates upward pressure on the domestic price (it rises toward Pw + subsidy)
   • As domestic price rises:
     • Domestic production increases (producers are incentivized to produce more)
     • Domestic consumption decreases (consumers face higher prices)
     • Exports increase (difference between higher production and lower consumption)

4. Key effects:

   • Domestic price increases (not decreases)
   • Domestic production increases (not decreases)
   • Domestic consumption decreases (correct answer)

Therefore, an export subsidy in a small country leads to:

• Higher domestic prices
• Increased domestic production
• Decreased domestic consumption
• Increased exports

The correct answer is C because consumers face higher prices due to the subsidy, leading them to consume less of the good domestically.