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Technological Linkages, Market Structure, and Optimum Production Policies

  • Douglas Holtz-Eakin
  • Mary E. Lovely

There has been an increased interest in the efficacy of industrial policy. We show that policy design for vertically-related industries hinges on the nature of market interactions as well as technological linkages. Using a model in which final-good producers realize productivity gains from increasing domestic specialization of intermediate processes, we find no theoretical basis for presuming that an imperfectly competitive intermediates sector restricts output below the optimal level or that the market produces too many varieties. The direction of distortion depends on the relationship between the extent of the external economy and the market power of individual intermediates producers. Optimal corrective policies require two instruments: an output subsidy and a lump-sum tax or subsidy. If only one instrument is available, it may be optimal to tax instead of subsidize the externality-generating activity.

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File URL: http://www.nber.org/papers/w4779.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4779.

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Date of creation: Jun 1994
Date of revision:
Publication status: published as Journal of Public Economics, vol. 61, 1996, pp. 73-86
Handle: RePEc:nbr:nberwo:4779
Note: PE
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  1. Spence, Michael, 1976. "Product Selection, Fixed Costs, and Monopolistic Competition," Review of Economic Studies, Wiley Blackwell, vol. 43(2), pages 217-35, June.
  2. Flam, Harry & Helpman, Elhanan, 1987. "Industrial policy under monopolistic competition," Journal of International Economics, Elsevier, vol. 22(1-2), pages 79-102, February.
  3. Markusen, James R, 1989. "Trade in Producer Services and in Other Specialized Intermediate Inputs," American Economic Review, American Economic Association, vol. 79(1), pages 85-95, March.
  4. Carlton, Dennis W & Loury, Glenn C, 1980. "The Limitations of Pigouvian Taxes as a Long-Run Remedy for Externalities," The Quarterly Journal of Economics, MIT Press, vol. 95(3), pages 559-66, November.
  5. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
  6. Joseph F. Francois, 1992. "Optimal Commercial Policy with International Returns to Scale," Canadian Journal of Economics, Canadian Economics Association, vol. 25(1), pages 184-95, February.
  7. Ethier, Wilfred J, 1982. "National and International Returns to Scale in the Modern Theory of International Trade," American Economic Review, American Economic Association, vol. 72(3), pages 389-405, June.
  8. Markusen, James R., 1990. "Derationalizing tariffs with specialized intermediate inputs and differentiated final goods," Journal of International Economics, Elsevier, vol. 28(3-4), pages 375-383, May.
  9. Venables, Anthony J., 1982. "Optimal tariffs for trade in monopolistically competitive commodities," Journal of International Economics, Elsevier, vol. 12(3-4), pages 225-241, May.
  10. James R. Markusen, 1990. "First Mover Advantages, Blockaded Entry, And the Economics of Uneven Development," NBER Working Papers 3284, National Bureau of Economic Research, Inc.
  11. Ethier, Wilfred, 1979. "Internationally decreasing costs and world trade," Journal of International Economics, Elsevier, vol. 9(1), pages 1-24, February.
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