Optimal Subsidy and Tariff in a Two-country Model∗

∗ We are grateful to various seminar audiences for useful comments and suggestions. Any remaining errors are my sole responsibility. † Corresponding author Optimal Subsidy and Tariff in a Two-country Model The paper examines the optimal policy on subsidy and import tariff under international oligopoly in a two-country model. We show that the optimal subsidy provided to domestic firms always deters foreign firms from entering the domestic market, whereas imposing an optimal tariff on foreign firms allows foreign firms to enter the market. In addition, it is shown that the domestic government can bring about greater domestic welfare by subsidizing the domestic firms than by imposing a tariff on foreign firms. The results suggest that the national government prefers the subsidy policy to the tariff policy in order to restrict import