“Public Rationing and Private Cost Incentives” by Albert MA
Hong Kong University of Science and Technology
This paper considers a public provider's strategic use of rationing in a market served by both public and private providers. Such a "mixed" market structure is common in many industries such as health care, telecommunication, postal service, and public utilities. The technology in the private sector exhibits increasing returns: each firm can expend "effort" in the form of fixed cost to reduce the marginal cost. Firms in the contestable private sector compete and the market equilibrium is characterized by average-cost pricing. The equilibrium private sector market share is too low, resulting in deficient effort. Efficient rationing forces more consumers to use the private sector, restoring cost incentives and implementing the first best. Random rationing may reduce cost inefficiency but does not implement the first best.