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

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.