Welfare Improving Contracts in Cournot Markets

The question this paper addresses is whether a government can regulate a Cournot oligopolist market to give higher level of welfare without changing either the strategic variable (output quantity) or the way prices are determined (by an auctioneer). The problem is set as a two- stage game played by profit-maximizing firms and a welfare-maximizing government. Firms are symmetric in capacity and technology but asymmetric in ownership. The government owns one firm and uses it strategically. The main policy implication of the model is that by owning and controlling one single firm, a government can regulate an entire industry and achieve welfare improvements. This is possible as the decision-making asymmetry among privately and publicly owned firms allows the government to change the context in which the quantity competition takes place. In addition, this paper shows that the social objectives of the government are not incompatible with profit maximization targets. The government improves the \QTR{it}{total }welfare of the economy if and only if it maximizes profits in its own firm. We shall see that, in equilibrium, the publicly-owned firm maximizes profit either by producing the Stackelberg leader output or the competitive output.