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When comparing the two policies, it largely depends on the government’s priorities. If the government’s main aim is to promote production within the economy and increase the demand that way, subsidies are likely to be the best option. Direct provision will be especially useful if the government is in need of increasing supply for goods and services that are underprovided in the market.

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Pro of subsidies is the promotion of firms within the area by subsidizing them to increase supply. This will help the economy and its production levels. On the other hand, if not used efficiently, it may be no help at all, as it will have a greater cost to society than it will have benefits.

An advantage of direct provision is the ability to reliably produce a given product effectively, which can be useful in desperate situations. The main con of direct provision is that it will be supplied by the public sector, which is usually less efficient than the more competitive private sector.

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However, subsidies may be a better long-term solution than short-term, since it will require time for the firms to utilise the subsidies correctly and for the consumer demand to show a noticeable change. In the short-term, the direct provision may have a greater effect as extra supply will be introduced by the government right away.

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As discussed previously, direct provision can serve to solve market failures. For example, during the ongoing COVID-19 pandemic, Singapore has engaged in the mask market whenever a severe haze or shortage occurred. They directly provided these products as they were in very high demand despite there being a relative shortage, especially towards the beginning of 2020. The fact that masks are considered merit goods which provide an external benefit to society, hence increasing the importance of their supply to the Singaporean government. The direct provision increased supply until new firms entered the market and had the resources to sell masks. Additionally, education is often an industry that can become subject to subsidies due to the marginal benefits that consumers are provided with. The federal American government generally spends about $80 billion per year on higher education, as the demand is increasing every year. Considering that academics at this level are becoming more available to the general public and how it is deemed as an excellent experience for those looking to be employed, the government grants these subsidies in order to pursue these opportunities.

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Since the external benefit is not considered in the demand curve of a merit good (it only equals the private benefits), the market equilibrium is not at the social optimum of c, where MSB = MSC. Though it is difficult to shift the demand curve to the right by increasing demand over time, the government can affect the supply levels to reach the desired quantity demanded.

Subsidy is one way to achieve that since it will help the producers to cover their costs and supply more of the good or service, which can be represented as a shift from S1 to S2. With the help of the subsidy, the suppliers will be able to supply at lower prices and higher quantity. Lower prices will attract more consumers, which can be represented as an extension of demand from a to b. Thus, the market equilibrium is at the social optimum level in terms of quantity demanded and supplied.

Direct provision achieves a similar effect, as the government increases the supply of the good or service, meaning the supply curve was shifted from S1 to S2. The additional supply from the government that usually does not have the goal of profit-maximisation allows for higher quantity supplied at lower prices. Lower prices attract more consumers, shown in the extension from a to b, reaching the desired social optimum.

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Public goods are goods that are both non-excludable and non-rivalrous, practically a benefit or well-being to the general public. These are usually supplied by the government.

Merit goods are goods that bring an external benefit to the society as a result of consumption.

Market failure is defined as an inefficiency in a market for a particular good, with resources not being allocated effectively.

The market failure for merit goods is caused by a divergence between marginal private benefits and marginal social benefits curves, whereas for public goods, they are created through consumers not paying for the products but still using them nonetheless.

To fix such market failures, the government may implement different policies, for example, subsidies and direct provision.

A subsidy is a sum of money granted by the government in attempts to increase supply for a product in a given market structure.

Direct provision is when governments intervene in a market by engaging in the supply of goods themselves to increase supply to keep up with demand.