Let A1 denote the vector of firm specific profitabilities for which π(Λ',B) =0,
for a given B. In addition, firms can decide to change the production location and
go abroad. In this case, firms have to bear the migration cost C which is equal
across firms. Without loss of generality, we normalize location-specific profitability
abroad to zero. Suppose that the foreign government sets its tax rate to t and the
rate of depreciation allowances to β. The firm stays in the home country if
π («, a) ≥ π* (t, β) — C (12)
where the asterisk denotes the foreign country and. Ah denotes the vector of
firm specific profitabilities which satisfy π = π* — C.
3.2 Households
Domestic households own all firms in the economy. Profits are their only source
of income. Household consumption is therefore:
ZB+ ∕∙Ah ∕∙B+ pA+
j [π] dAdB + J J
[π* — C] dAdB
(13)
with
π = F (K,A,B)(1 — u) — (1 — au) K (14)
π* = F (K *,A,B )(1 — t) — (1 — βt) K * (15)
3.3 Government
The government uses profit tax revenue to finance the public good g. The budget
constraint of the government is given by
bB+ rAh
Bb- Aa1
u (F (K, A, B)
— aK) dAdB
(16)
The government is supposed to maximize the social welfare function W :
W = U (c) + H (g)
(17)