Subsidy

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A subsidy (also known as a subvention) is a form of financial assistance paid to a business or economic sector. Most subsidies are made by the government to producers or distributors in an industry to prevent the decline of that industry (e.g., as a result of continuous unprofitable operations) or an increase in the prices of its products or simply to encourage it to hire more labor (as in the case of a wage subsidy). Examples are subsidies to encourage the sale of exports; subsidies on some foods to keep down the cost of living, especially in urban areas; and subsidies to encourage the expansion of farm production and achieve self-reliance in food production.[1]

Subsidies can be regarded as a form of protectionism or trade barrier by making domestic goods and services artificially competitive against imports. Subsidies may distort markets, and can impose large economic costs.[2] Financial assistance in the form of a subsidy may come from one's government, but the term subsidy may also refer to assistance granted by others, such as individuals or non-governmental institutions, although these would be more commonly described as charity.

Contents

Overview

In standard supply and demand curve diagrams, a subsidy will shift either the demand curve up or the supply curve down. A subsidy that increases the production will tend to result in a lower price, while a subsidy that increases demand will tend to result in an increase in price. Both cases result in a new economic equilibrium. Therefore it is essential to consider elasticity when estimating the total costs of a planned subsidy: it equals the subsidy per unit (difference between market price and subsidized price) times the new equilibrium quantity. One category of goods suffers less from this effect: Public goods are—once created—in ample supply and the total costs of subsidies remain constant regardless of the number of consumers; depending on the form of the subsidy, however, the number of producers on demanding their share of benefits may still rise and drive costs up.

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