Optimal Subsidy Design for Productive Investment across Markets

Abstract

We study the optimal design of investment subsidies across heterogeneous monopolistic markets subject to a common expected discounted budget. Each producer faces a regular one-dimensional demand diffusion and chooses irreversible capacity expansion through a singular stochastic control problem. The regulator values weighted consumer surplus, producer profits, and an additional benefit from installed capacity, while accounting for the excess cost of raising public funds. We characterize producers' optimal investment responses through free boundaries and reformulate the regulator's stochastic optimization problem as a deterministic optimization over investment boundaries. An integral representation then recovers the optimal subsidy schedules that implement the resulting capacity policies. Under mild conditions on the diffusions, we establish existence of optimal schedules and uniqueness of the induced investment policies. Finally, we characterize the subsidy schedule and provide numerical illustrations.