State aid in the European Union: The prohibition of subsidies in an integrated market

The effect of prohibiting state aid in an integrated market is analysed in a symmetric Cournot oligopoly model where one firm is located in each membe r state. Subsidies are financed by distortionary taxation so there is a tra de-off between the deadweight loss from the oligopolistic distortion and th at from distortionary taxation. It is shown that there exists a range of va lues for the opportunity cost of government revenue where member states wan t to give subsidies and where the multilateral prohibition of subsidies wou ld increase aggregate welfare. Furthermore, this range of values is shown t o include plausible estimates of opportunity cost. (C) 2000 Elsevier Scienc e B.V. All rights reserved.