Q.
What the negative impacts of subsidy to the economic health of a nation?
A.
Competitive equilibrium is a state of balance between buyers and suppliers, in which the quantity demanded of a good is the quantity supplied at a specified price. When the quantity demanded exceeds the equilibrium quantity, price falls; conversely, a reduction in the supply of a good beyond equilibrium quantity implies an increase in the price.[8]
The effect of a subsidy is to shift the supply or demand curve to the right (i.e. increases the supply or demand) by the amount of the subsidy. If a consumer is receiving the subsidy, a lower price of a good resulting from the marginal subsidy on consumption increases demand, shifting the demand curve to the right. If a supplier is receiving the subsidy, an increase in the price (revenue) resulting from the marginal subsidy on production results increases supply, shifting the supply curve to the right.
Assuming the market is in a perfectly competitive equilibrium, a subsidy increases the supply of the good beyond the equilibrium competitive quantity. The imbalance creates deadweight loss. Deadweight loss from a subsidy is the amount by which the cost of the subsidy exceeds the gains of the subsidy.[9] The magnitude of the deadweight loss is dependent on the size of the subsidy. This is considered a market failure, or inefficiency.[9]
Subsidies, by lowering the price of a good, make national goods more competitive against foreign goods, thereby reducing foreign competition.[10] As a result, many developing countries cannot engage in foreign trade and receive lower prices for their products in the global market. This is considered protectionism: a government policy to erect trade barriers in order to protect domestic industries.[11] The problem with protectionism arises when industries are selected for nationalistic reasons (Infant-Industry), rather than to gain a comparative advantage. The market distortion, and reduction in social welfare, is the logic behind the World Bank policy for the removal of subsidies in developing countries.[8]
Subsidies create spillover effects in other economic sectors and industries. A subsidized product sold in the world market lowers the price of the good in other countries. Since subsidies result in lower revenues for producers of foreign countries, they are a source of tension between the United States, Europe and poorer developing countries.[12] While subsidies may provide immediate benefits to an industry, in the long-run they may prove to have unethical, negative effects.
Subsidies are intended to support public interest, however, they can violate ethical or legal principles
if they lead to higher consumer prices or discriminate against some producers to benefit others.[10] For example, domestic subsidies granted by individual US states may be unconstitutional if they discriminate against out-of-state producers, violating the Privileges and Immunities Clause or the Dormant Commerce Clause of the United States Constitution.[10] Depending on their nature, subsidies are discouraged by international trade agreements such as the World Trade Organization (WTO).
Ref:
Wikipedia search "subsidy"
http://en.m.wikipedia.org/wiki/Subsidy