Injury-based protection with auditing under imperfect information

We analyze optimal protection when a benevolent government must maintain no nnegative domestic profits and when the domestic import-competing firm has private information about its costs. A costly audit mechanism can deter str ategic manipulation of this private information. We show that a high penalt y/low probability of investigation is optimal when the shadow price of the firm profit is low compared with the audit cost. A low penalty/high probabi lity of investigation is optimal when there is a low investigation cost and a high shadow price of hrm profit. in this latter case, the trade authorit y obtains truthful announcements by directly auditing the firm.