UNIFORM OUTPUT SUBSIDIES IN AN ECONOMIC UNION WITH FIRMS HETEROGENEITY

In this paper we show the importance of cost asymmetry and demand curvature in the effect of a uniform output subsidy policy in an economic union. We consider an economic union formed by two countries each with a single firm producing a homogeneous good. We find that when firms have different cost, the optimal level of the uniform subsidy can be negative if the demand is concave enough. The low cost firm expands its market share if the demand function is sufficiently convex whereas in the case of a concave demand function it is the higher cost firm which gains market share. This implies that a uniform output subsidy policy may cause a change in production e¢ciency. Finally, we consider how a divergence between private and social costs of public funds may a¤ect the desirability of such a subsidy policy.