A subsidy is a grant or monetary gift given by a private person or entity (often a government) to another private person or entity, as financial assistance or to help launch an enterprise. Critics of government interventions in free markets often use a wider definition, arguing that whole industries have come to rely on subsidies without accepting that label; these critics consider any form of production subsidized if it does not bear the full costs of its operation, be it due to acquiescence or support by the state. Supporters of subsidies often justify their use as intended for some socially beneficial purpose, although economists point out that subsidies may often have socially detrimental effects.
In standard supply and demand curve diagrams, a subsidy will shift either the demand curve up (subsidized consumption) or the supply curve down (subsidized production). Both cases result in a new, higher equilibrium quantity. Therefore, it is essential to consider the price elasticity of demand when estimating the total costs of a planned subsidy: it equals the subsidy per unit (difference between market price and subsidized price) times the higher equilibrium quantity. One category of goods suffers less from this effect: Public goods are -- once created -- in ample supply and the total costs of subsidies remain constant regardless of the number of consumers; depending on the form of the subsidy, however, the number of producers demanding their share of benefits may still rise and drive costs up.
A subsidy normally exemplifies the opposite of a tax, but can also be given using a reduction of the tax burden. These kinds of subsidy are generally called tax expenditures.
Monetary policy as a systematic subsidy
Prevailing exchange rates may themselves be unfair and can be the cause of trade disputes and trade sanctions. For example at the moment China pegs its currency, the renminbi, to the US dollar, but it is being argued, not least by the United States, that this fixed exchange rate gives China an unfair pricing advantage in the United States (mainly because Chinese labour costs are enormously lower than those in the USA). A fixed exchange rate removes the possibility of trade imbalances (surpluses and deficits of trade) being adjusted via the exchange rate. China is arguing at the moment that volatility of its exchange rate would add a dangerous element of instability into its still underdeveloped economy and financial system.