Subsidies to Public Firms and Competition Modes under a Mixed Duopoly

This study experimentally examines whether subsidies to a state-owned enterprises (SOE) change the behavior of a private firm or the SOE under a mixed duopoly. Following Hampton and Sherstyuk (2012), we conducted a series of laboratory experiments adopting a two-stage capacity-price decision-making duopoly setting. We adopted two treatments in terms of types of subsidies: one is a subsidy for production/sales and the other is a subsidy for capacity building. The results indicate that even a small amount of subsidy can influence the choices of capacities and prices of both types of firms. Production subsidies increase capacities of both private firms and SOEs, and, accordingly, the prices of both types of firms decrease, while capacity subsidies decrease capacities of private firms. Because the competition for capacity building between two firms becomes less severe, the profits of both firms increase and, interestingly, the idle capacities of private firms decrease. Moreover, both social and domestic surpluses increase in the case of production subsidies, but decrease in the case of capacity subsidy. In the former case, severe competition mitigates the distortion caused by imperfect competition. We also find that the firm attributes and behavior in the past significantly influence capacity choices.