How Do Subsidies Work?

Sometimes, a government or other large entity will attempt to provide incentives for certain behaviors of players within a particular market. For example, a government may choose to provide a tax credit or other payment to a company that produces alternative energy. Financial incentives provided by a government that encourage certain behaviors, particularly the production of goods, are known as subsidies. Subsidies can fulfill an important role, but they also have various problems.



The definition of a subsidy is relatively broad, as it can encompass any time that the government pays money to an individual or organization because it has performed a particular action. However, the term is most often used to refer to payments made to companies that grow or mine certain products or to parties who are seeking to purchase a particular product.


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When parties who either produce or purchase a product receive subsidies, it provides an incentive to parties to continue to produce this product or to buy it. This encourages the product's production and consumption. This may encourage behaviors with positive ancillary effects. For example, if the government subsidizes the production of green energy, this can lead to a decrease in pollution.



Government subsidies are an excellent way of supporting the production of goods and services that the free market does not have sufficient motivation to produce, but which fulfills a vital need. For example, a government that worries that energy is too expensive may wish to help subsidize its production or purchase, thereby leading to a cheaper price for consumers, and allowing more people to heat and light their homes.



Critics complain that subsidies distort the functioning of the free market and lead to unnecessary expenses. For example, as the time of publication, the U.S. government spends millions of dollars each year paying farmers who are not using land to grow corn and other crops, as a means of keeping the price at a level that allows other farmers to survive. Some say that allowing the free market to dictate the price of corn would save the government and consumers money.