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Subsidy

Assistance given by the government to individuals or businesses in the form of cash or grants that helps reduce the prices of products

What is a Subsidy?

A subsidy is an incentive given by the government to individuals or businesses in the form of cash, grants, or tax breaks that improve the supply of certain Goods and Services. With subsidies, consumers are able to access cheaper products and commodities. Markets that have positive externalities, which are extra benefits to society, tend to be favored in policy to provide a greater supply of that good and service.

Subsidy - Image of a check with subsidy written on it

 

Basically, subsidies are provided by the government to specific industries with the aim of keeping the prices of products and services low for people to be able to afford them and also to encourage production and consumption.

 

Types of Subsidies:

 

#1. Production subsidy

This type of subsidy is provided in order to encourage the production and consumption of a product. In order for manufacturers to increase their production output, the government compensates for some of its parts in order to lessen their expense while increasing their output. As a result, production and consumption grow, but the price remains the same. The drawback of such an incentive though is that it promotes overproduction and incurs the cost for product storage.

 

#2. Consumption subsidy

It happens when the government offsets the costs of food, education, healthcare, and water. Very popular in education, this is commonly

 

#3. Export subsidy

An obvious fact is that a country or state earns from its exports and balances its economy. That is why to encourage export, the government subsidizes the cost. However, this can be easily abused, especially by exporters who exaggerate the prices of their goods so that they receive a larger incentive, eventually raising their profits at the expense of the government’s spending.

 

#4. Employment subsidy

This incentive is given by the government to companies and organizations in order to enable them to provide more job opportunities.

 

Advantages of Subsidies:

 

#1. Lowering prices and controlling inflation

They are especially applicable in the area of fuel prices, particularly when global crude oil prices are rising. Many countries subsidize fuel costs in order to keep its prices from ballooning.

 

#2. Preventing the long-term decline of industries

There are many industries that should be kept alive and functional such as fishing and farming. With many new and fast-growing industries, they two might be compromised and suffer a major decline.

 

#3. A greater supply of goods

Governments want to increase the access of their population to Goods & Services such as Water, Food, and Education. They, therefore, provide an incentive that could be in the form of a tax credit, or even straight up cash. Markets that have positive externalities are usually the ones that receive such benefit.

 

Disadvantages of Subsidies

 

#1. Shortage of supply

Though one of the advantages of subsidies is the greater supply of goods, a shortage of supply can also occur. It is because lowered prices can lead to a sudden rise in demand that many producers may find very hard to meet. Ultimately, it can lead to high demand, which causes an increase in prices.

 

#2. Difficulty in measuring success

For obvious reasons, subsidies are effective, and they greatly help people in general. However, if the government were to make a report of its success in making subsidies, it would be a different story. It is because it is hard to quantify the success of subsidies, which makes it even harder to assess for its future implementation and modification.

 

#3. Higher taxes

How will the government raise funds to use for subsidizing industries? Of course, by imposing higher. So, it is the people who provide the means to enable the government to subsidize industries that they are able to enjoy ultimately.

 

More Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Deadweight Loss
  • Supply and Demand
  • Externality
  • Network Effect

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