Thursday, December 9, 2010
Posted by D. Daniel Sokol
Jan Bouckaert & Bruno De Borger (both University of Antwerp - Economics) discuss Price competition between subsidized organizations.
ABSTRACT: Many firms and organizations compete for customers while at the same time receiving substantial funding from outside sources, such as government subsidies. In this paper, we study the effects of two commonly observed, alternative subsidy systems on the behavior of price-competing firms. Specifically, we compare an open-ended per-unit price subsidy with a closed-ended subsidy, allocated according to the firms’ market shares. We find that, holding the total subsidy budget constant, the open-ended subsidy results in fiercer price competition, lower prices, higher output, and lower profits than the closed-ended, market-share based alternative. Second, the open system yields higher overall welfare for relatively modest subsidies and limited substitutability between goods; the closed system performs better at relatively high subsidy levels and when goods are closer substitutes. Third, a market-share based subsidy makes collu! sive behavior between firms much harder. Our results, therefore, suggest a potential trade-off between short-run and long-run objectives: subsidies designed to widen participation may stimulate collusive behavior.