A Break-even Tax-subsidy Scheme to Realize First-best Welfare

This paper proposes a break-even tax-subsidy scheme designed with an entry tax and a production subsidy to regulate imperfect competition. The first-best social optimum incorporating marginal cost pricing, minimum-average-cost output, and socially optimal number of firms is achieved. In the regulation, free entry and the independent choice of price and output are retained and the tax-subsidy scheme is the outcome of a well-defined market process. A diagrammatic exposition is provided to show that the first-best welfare can be achieved under imperfect price mechanisms as long as the social planner identifies the structure of firm's production costs. I believe this provides a new way of dealing with the conflicts between government authority and price mechanisms