Subsidies Theory: General Theory and Analysis

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A subsidy is a form of financial assistance paid by a government to an entity for implementing a practice or performing a specified action. Subsidies may take the form of direct payments, tax reductions, or price supports.

A subsidy creates a new economic equilibrium by either shifting the demand curve up or the supply curve down. A subsidy that increases production will generally result in a lower price, while a subsidy that increases demand will generally result in an increase in price. Because subsidies distort economic markets, they can impose economic costs. Public goods suffer less from this effect because, once created, they are in ample supply and the total costs of subsidies remain constant regardless of the number of consumers.

Subsidies have politically positive distributional consequences. Because the costs of a subsidy are distributed broadly through society while the benefits are concentrated, subsidies may be politically easier to implement than regulatory policy instruments.