Edgeworth's taxation paradox when firms engage in cost‐reducing investment

Abstract This study examines whether and when Edgeworth's taxation paradox, that taxation decreases the equilibrium price, occurs in a free‐entry Cournot oligopoly with cost‐reducing investment. In contrast to the fact that no paradox occurs in the short‐run equilibrium, the paradox can occur in the long‐run equilibrium, in which the number of firms is endogenous. However, the conditions under which the paradox occurs are restrictive when there is no investment. By incorporating cost‐reducing investments into the model, we demonstrate that the paradox is likely to occur under less restrictive conditions, irrespective of whether the tax is specific or ad valorem.