Improving consumer welfare and manufacturer profit via government subsidy programs: Subsidizing consumers or manufacturers?

Abstract

Most consumers in rural areas of many developing countries cannot afford to purchase certain livelihood improvement products such as home appliances. To improve consumer welfare and manufacturer profit, many governments launch different types of subsidy programs that offer subsidies to consumers, manufacturers, or both. Motivated by a subsidy program developed by the Chinese government in 2007, we present a parsimonious model to determine the optimal subsidy program in different settings so as to gain a better understanding about the conditions under which it is optimal for the government to subsidize consumers only, manufacturers only, or both. Our analysis reveals that the structure of the optimal subsidy program (i.e., subsidize consumers only, manufacturers only, or both) depends on: (a) whether there is a well-established market selling price for the products; and (b) the relative emphasis that the government places on consumer welfare versus manufacturer profit. Also, we find that government can improve consumer welfare by developing subsidy programs that involve multiple (competing) manufac- turers with different market sizes and adequate capacities. Moreover, when using an earmarked budget to develop a subsidy program that is intended to improve social welfare (manufacturer profit and consumer welfare), we find that it is more effective for the government to subsi- dize consumers only. Our findings provide insights for developing effective government subsidy programs.