Question

1. A single firm’s innovations in production technology often benefit the production of other firms because these other firms learn about the new technology and can use some of the ideas in their own production.

1. Is there an externality here?
2. How would an economist rank the following two policies in this situation? Why?
   1. A tariff on imports, to make sure that domestic production using the new technology occurs.
   2. A subsidy to domestic production, to make sure that domestic production using the new technology occurs.
3. What third policy (a tax or a subsidy to something) would the economist recommend as even better than these two?

Please Explain them in detail and No bad handwriting please! Thanks! :)

Answer 1

1):-Yes, there are external benefits, a positive spillover effect. The benefits to the the entire country a larger than the benefits to the single firm innovating the new technology. Other firms that do not pay anything to this firm receive benefits by learning about and using the new production technology.

2) :-i. A tariff on imports, to make sure that domestic production using the new technology occurs

ii. A subsidy to domestic production, to make sure that domestic production using the new technology occurs.

3):-The economist would say that the production subsidy is preferable to the tariff. Both can be used to increase domestic production, but the tariff distorts domestic consumption, leading to an unnecessary dead-weight loss (consumption effect).
The economist would use the specificity rule. The actual problem is that innovating firms do not have enough enough incentives to pursue new production technologies (because other firms get benefits without paying). The economist would recommend some type of subsidy to new production technology as better than a tariff or production subsidy. The technology subsidy could be a subsidy to undertake research and development, or monetary awards or prizes for new technology once it is devloped.