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Coping with Inefficiencies in a New Economic Geography Model

Theresa Grafeneder-Weissteiner, Ingrid Kubin (), Klaus Prettner (), Alexia Fürnkranz-Prskawetz and Stefan Wrzaczek

No 1204, VID Working Papers from Vienna Institute of Demography (VID) of the Austrian Academy of Sciences in Vienna

Abstract: This article introduces a social planner version of a model central to the New Economic Geography for explicitly answering whether the symmetric equilibrium outcome of the decentralized market economy is socially desirable. We find that savings incentives are too weak, resulting in an inefficiently low capital stock and therefore an inadequate number of product varieties. The optimal subsidy and taxation scheme to remedy these distortions resulting from the monopolistic competition structure is shown to be a sales subsidy financed by a lump-sum tax that results in marginal cost pricing. Interestingly, implementing this optimal policy might actually destroy the stability of the symmetric equilibrium and result in unintended agglomeration processes.

Keywords: New Economic Geography; Constructed Capital Model; Social Planner; Regional Policy; Agglomeration (search for similar items in EconPapers)
Pages: 26 pages
Date: 2012-05
New Economics Papers: this item is included in nep-geo and nep-ure
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