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Foreign Direct Investment and Development-agency Intervention: A Theoretical Model

Department of Economic Studies, University of Dundee, Dundee, DD1 4HN, UK, j.h.l.dewhurst{at}dundee.ac.uk

A model is proposed in which there are two regions that differ in terms of size. There are two firms, one located in each region, producing a homogeneous product. The firms have identical cost functions and act as Cournot oligopolists. Transporting the product between the two regions is costly. A foreign firm is to establish a plant in one of the regions. The foreign firm experiences higher fixed costs, but has lower marginal costs, than the domestic firms. The optimal location of the foreign firm's plant is determined. It is then assumed that there exists a regional-development agency (in the region not chosen by the foreign firm) that can commit funds to defray the fixed costs of the foreign firm, if it were to choose to locate in its region. The amount of the subsidy necessary to induce the foreign firm to alter its choice is determined and the implications for the levels and regional distributions of price, output, employment and welfare are compared with the position that would have arisen without the development agency's intervention.

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