Thus, a domestic consumption tax can cause a commodity to be exported. If a small country is importing or exporting a commodity initially, a domestic policy will affect the quantity imported or exported, the prices faced by consumers or producers and the welfare of consumers, producers, the government, and the nation. We consider two examples in this section. In the first case , we consider a production subsidy implemented by a small country which initially is importing the commodity from the rest of the world. The production subsidy stimulates domestic production by raising the producers' price, but, has no effect on the world price or the domestic consumers' price.
Imports fall as domestic production rises.
Consumers face the same international price before and after the subsidy, thus their welfare is unchanged. The government must pay the unit subsidy for each unit produced by the domestic firms and that represents a cost to the taxpayers in the country. The net national welfare effect of the production subsidy is a welfare loss represented by a production efficiency loss. Note, however, that the national welfare loss shown here arises under an assumption that there are no domestic distortions or imperfections. If market imperfections are present then a production subsidy can improve national welfare.