The effectiveness of temporary marginal cost subsidies

Abstract

The principal aim of a marginal cost subsidy program is to accelerate improvements in economic performance that would occur anyway if anticipated changes in the relevant economic determinants were to realise. The potential effectiveness of such a program is studied in a framework that allows firms to have stochastic beliefs as to the timing of the change in the economic environment and the ending of the subsidy program. Because the subsidies are typically of a temporary nature and apply only to incremental changes, they create an incentive for firms to actually postpone changes in performance. Leaving the ending date unspecified at the time of implementation of the program may counteract this incentive and results in an early accelerative response. The improvement in economic performance near the specified termination date for a program with a known length, however, may well be more substantial.