NEGATIVE DEMAND SHOCKS, KNOCK-ON EFFECTS AND EMERGENCY GOVERNMENT BAILOUTS

Authors

  • DAPENG CAI,

    1. Institute of Advanced Research, Nagoya University
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  • JIE LI

    1. School of Economics, Zhejiang University
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    • The first author acknowledges financial support from the grant-in-aid (23730232), the Japanese Ministry of Education, Culture, Sports, Science and Technology and the Japan Economic Research Foundation. The second author (the corresponding author) acknowledges financial support from the Key Research Base of Social Science, Zhejiang Province, P. R. China (09JDQY002Z), and the Project of Humanities and Social Sciences for Young Scholars, the Chinese Ministry of Education (10YJC790130). The authors wish to thank Ryuhei Okumura, Nobuki Sugita, the editor, the co-editor and the anonymous referee for their valuable comments. The authors are, of course, entirely responsible for all remaining errors.


  • Manuscript received 16.7.10; final version received 7.4.11.

Abstract

In this paper we consider emergency government bailouts. We show that it is welfare-enhancing to bail out failing firms that are facing a sudden negative demand shock and would otherwise go bankrupt, when there are sufficiently large fixed production costs and knock-on effects (the negative externalities produced by firms' failures that impact on other firms). We also suggest that subsidizing the whole industry at a uniform production subsidy generates a higher level of national welfare than merely subsidizing the failing firms.

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