Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/208525 
Year of Publication: 
2006
Series/Report no.: 
Working paper No. 8-2006
Publisher: 
Copenhagen Business School (CBS), Department of Economics, Frederiksberg
Abstract: 
Welfare ranking of policy instruments is addressed in a two-sector Ramsey model with monopoly pricing in one sector as the only distortion. When government spending is restricted, i.e. when a government is unable or unwilling to finance the required costs for implementing the optimum policy, subsidies that directly affect investment incentives may generate higher welfare effects than the direct instrument, which is a production subsidy. The driving mechanism is that an investment subsidy may be more cost effective than the direct instrument; and that the relative welfare gain from cost effectiveness can exceed the welfare loss from introducing new distortions. Moreover, it is found that the investment subsidy is gradually phased out of the welfare maximizing policy, which may be a policy combining the two subsidies, when the level of government spending is increased.
Subjects: 
welfare ranking
indirect and direct policy instruments
restricted government spending
JEL: 
E61
O21
O41
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by-nc-nd Logo
Document Type: 
Working Paper

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