Optimal policy choice and asymmetric information in a mixed market

Abstract

In a public-firm monopoly market, we investigate a welfare-maximizing government’s attitude towards the entry of a private firm with private information in cost and the government’s choices over two policy options: a menu of policies and a uniform policy. Two different cases are considered: the case of a domestic private firm and the case of a foreign private firm. In both cases, allowing the entry of the private firm is socially optimal. However, in the first case, policy menu is preferred to uniform policy; in the second case, separation equilibrium does not exist and uniform policy is adopted.

Keywords:

• asymmetric information
• public firm
• private firm
• mixed oligopoly

JEL Codes:

• L13
• L32
• P20

Acknowledgements

This research is partially supported by grants from the Key Project of Key Research Institute of Humanities and Social Sciences at Universities, Chinese Ministry of Education (2009JJD790044), Program for New Century Excellent Talents, Chinese Ministry of Education (NCET-07-0746), and Project of Humanities and Social Sciences, Chinese Ministry of Education (10YJC790130). The authors wish to express their appreciation to the Editor, Eden Yu, and to an anonymous referee for valuable comments. The authors are, of course, entirely responsible for all remaining errors.

Notes

1. Mixed markets refer to the market structure in which a homogeneous or differentiated good is supplied by a “small” number of firms and the objective function of at least one of them differs from that of the other firms. The term “mixed” is analogous to the term “mixed economies”, which refers to the simultaneous presence of private and public enterprises in economy (De Fraja and Delbono 1990). There has been an extensive literature concerning mixed oligopoly (see, e.g. De Fraja and Delbono 1990) for an excellent survey of earlier works).

2. In our model, it is assumed that the marginal cost of the high-cost-type private firm is lower than that of the public firm.

3. Reflecting the observation that incentives for efficiency are generally greater with private firms (Bös 1991, OECD 2005), we assume that the private firm has an advantage in technology relative to the public firm. We should also note that the output of a private firm that is less efficient than the public firm would be negative under mixed oligopoly with full information (see Equation (12)).

4. Negative subsidy is equivalent to tax. The shadow cost occurs when raising funds to subsidize the private firm, similar to those in Laffont and Tirole (1986, 1993), and Brainard and Martimort (1992).

5. Incentive-compatible policy menus have been examined extensively in the regulation literature, see for example, Baron and Myerson (1982), Caillaud et al. (1985), Laffont and Tirole (1986, 1993). This literature analyzes relationships between regulatory authorities and regulated firms, interaction between various interest groups and regulatory agencies, and regulatory hierarchies in the context of imperfect information.

6. Should the subsidy be the only instrument available to the government, firm 2 would have chosen the highest subsidy independent of its type. In this case, the menu of policies is not incentive compatible. In a real world, one could perhaps view the lump-sum tax as a tax on profit.

7. The full information subsidy is specified in (15).

8. We adopt the same notations defined before but interpret them in the context of a foreign private firm.

9. In a real world, one could perhaps view the lump-sum transfer as a privilege extended to firm 2.