Output Subsidies and Quotas under Uncertainty and Firm Heterogeneity

This paper studies the relative efficiency of two kinds of regulations, quantity restrictions (quotas) and output subsidies, in an imperfectly competitive market in the presence of two sources of uncertainty, costs and prices. We find that when these two sources of uncertainty are independently distributed, the output subsidy instrument has a comparative advantage over the quantity instrument. However, when we take into account the possibility of correlation between the random components and across firms' marginal costs, we find that a positive (negative) correlation tends to favor the quantity (subsidy) instrument. Finally, we show that when the correlation is positive, it is possible to find situations in which the quantity instrument has comparative advantages over the subsidy instrument.