Subsidies

A subsidy is a financial assistance provided by a government to reduce the costs of production for firms.

Purpose

This may be done for many reasons including:

to keep down the market prices of essential goods

to encourage greater consumption of merit goods

to contribute to a more equitable distribution of income

When paid to a producer, a subsidy has the opposite effect of an indirect tax – it is the equivalent of a fall in costs for the producer and results in a rightward shift in the market supply curve.

Government subsidies have a number of drawbacks.


It would be costly, and the government would have to raise enormous tax revenue.

There is a case to be made that when the government subsidises businesses, it diminishes their incentives to cut costs.
As a result, it is suggested that a government should refrain from subsidising businesses unless there is a clear social benefit.
A company that creates environmentally friendly technology, for example, may be able to provide society with a net positive externality, which could justify government support.
Milton Friedman made the point “There is nothing so permanent as a temporary government program.” The point is that once a pressure group starts receiving a subsidy, it becomes very difficult politically to remove that subsidy.