Strategic interaction in the market for charitable donations: The role of public funding

Government financing of charities influences their fundraising and private donations. To analyze competition between charities, we modify the model of fundraising introduced by Andreoni and Payne, where there are two groups of donors and two charities. We concentrate on warm‐glow motivation for giving and highlight strategic interaction in the market for donations. The charities are output‐maximizing, producing services with a purchased input and in‐house managerial supervision. In the absence of public funding, fundraising by charities are strategic complement given fixed costs. We show that block grants can change the nature of the competition, making fundraising strategic substitutes if grants exceed fixed costs. A charity receiving a grant will optimally reduce its fundraising, but the level of service provision will also be affected by the fact that the competing charity will solicit more intensively. The competitor will deliver more services because it benefits from the reduction in solicitation by the grant recipient. In this setting, matching grants work much like block grants as charities in both cases will compete less intensively for donations. That is, incentives for fundraising are weaker with matching grants. However, if both instruments are used the impact of a matching grant depends on whether the block grant over‐ or undercompensates for fixed costs. An optimal funding policy must account for this interaction effect as well as the fungibility of support working through charity competition in the market for donations.