Market failure happens when the free market follows demand and supply and allocates resources wrongly, causing negative externalities. Sometimes, a country might have a less comparative advantage than another in exporting a good or service.
To rectify these problems, the government might choose to provide selected markets with subsidies to encourage production, which would correct the externalities and make domestic producers more competitive in trade.
Definition
A subsidy is a payment made by the government to a group of firms within an industry. The primary purpose of this is to offset market failures and externalities in order to achieve higher economic efficiency. This is achieved as the quantity consumed increases at a lower market price.
Benefits
By providing a subsidy, the local firms will have more capital to invest and increase the quality of their products. There will also be possibilities for more employment. As the market becomes more competitive overseas and popular domestically, the firms will have more money to invest in physical and human capital, which can further improve the efficiency of their production process.
Cost
There are two main downsides to a subsidy. The opportunity cost of using this subsidy elsewhere is the first drawback. For example, the government can use it to increase government spending and GDP.
Some subsidies can be inefficient if the recipient does not use them correctly or does not dedicate them towards the intended purpose, which is the second issue.
Conclusion
Subsidies are payments made to markets that produce positive externality. This increases employment contributing towards economic growth. An increase in employment also makes the market more powerful and competitive in export markets.
However, the opportunity cost of a subsidy will be the ability to invest in other markets or expansionary policies. Additionally, some subsidies might not be used as intended, therefore, wasting the government budget.
