Department of Economics. University of Melbourne. Parkville Victoria 3052 Australia
ABSTRACT
When previously government-owned production facilities are transferred to the private sector, the incidence on social welfare is twofold. On one hand, it can save the production costs and thereby expand the aggregate production level to enhance welfare if the private entrepreneurship entails efficient operation and lowers the marginal producation cost. On the other hand, there arises a conflict between the welfare-maximising public sector and the profit-maximising private sector. This paper shows the possibility that, under certain conditions, it can be socially optimal for the public firm not to privatise its whole production capacity but to retain a part of it, even when private operation of the production facilities is strictly more cost-efficient than public operation. In particular, we observe that this possibility is more likely when these two sectors engage in repeated oligolpoly than static oligopoly. In the former case, in equilibrium, the public sector intentionally produces strictly below its retained capacity, leaving a part of its capacity idle.
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