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Is Subsidizing Inefficient Bidders Actually Costly?

  • Michael H. Rothkopf

    ()

    (Rutgers Business School and RUTCOR, Rutgers University, 640 Bartholomew Road, Piscataway, New Jersey 08854-8003)

  • Ronald M. Harstad

    ()

    (Rutgers Business School and RUTCOR, Rutgers University, 640 Bartholomew Road, Piscataway, New Jersey 08854-8003)

  • Yuhong Fu

    ()

    (Moody's, 96 Church Street, New York, New York 10007)

A widespread practice, particularly in public-sector procurement and dispersal, is to subsidize a class of competitors believed to be at an economic disadvantage. Arguments for such policies vary, but they typically assume that benefits of subsidization must be large enough to outweigh a presumed economic cost of the subsidy. When disadvantaged competitors compete in auctions, the subsidy serves to make them more competitive rivals. Other bidders rationally respond by bidding more aggressively. We consider a model of procurement auctions and show that a policy of subsidizing inefficient competitors can lower expected project cost and also enhance economic efficiency. Some subsidy is generally better than no subsidy for a wide range of parameters.

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File URL: http://dx.doi.org/10.1287/mnsc.49.1.71.12748
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Article provided by INFORMS in its journal Management Science.

Volume (Year): 49 (2003)
Issue (Month): 1 (January)
Pages: 71-84

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Handle: RePEc:inm:ormnsc:v:49:y:2003:i:1:p:71-84
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  1. Harstad, Ronald M., 1993. "Auctions With Endogenous Bidder Participation," Discussion Paper Serie B 251, University of Bonn, Germany.
  2. Andrew Schotter & Allan Corns, 1999. "Can Affirmative Action Be Cost Effective? An Experimental Examination of Price-Preference Auctions," American Economic Review, American Economic Association, vol. 89(1), pages 291-305, March.
  3. Michael H. Rothkopf, 1969. "A Model of Rational Competitive Bidding," Management Science, INFORMS, vol. 15(7), pages 362-373, March.
  4. Michael H. Rothkopf & Ronald M. Harstad, 1994. "Modeling Competitive Bidding: A Critical Essay," Management Science, INFORMS, vol. 40(3), pages 364-384, March.
  5. Bulow, Jeremy & Roberts, John, 1989. "The Simple Economics of Optimal Auctions," Journal of Political Economy, University of Chicago Press, vol. 97(5), pages 1060-90, October.
  6. Robert Wilson, 1977. "A Bidding Model of Perfect Competition," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 511-518.
  7. McAfee, R. Preston & McMillan, John, 1989. "Government procurement and international trade," Journal of International Economics, Elsevier, vol. 26(3-4), pages 291-308, May.
  8. Lebrun, Bernard, 1999. "First Price Auctions in the Asymmetric N Bidder Case," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(1), pages 125-42, February.
  9. Benjamin T. Smith & James H. Case, 1975. "Nash Equilibria in a Sealed Bid Auction," Management Science, INFORMS, vol. 22(4), pages 487-497, December.
  10. Milgrom, Paul R & Weber, Robert J, 1982. "A Theory of Auctions and Competitive Bidding," Econometrica, Econometric Society, vol. 50(5), pages 1089-1122, September.
  11. Harstad, Ronald M, 1990. "Alternative Common-Value Auction Procedures: Revenue Comparisons with Free Entry," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 421-29, April.
  12. William Vickrey, 1961. "Counterspeculation, Auctions, And Competitive Sealed Tenders," Journal of Finance, American Finance Association, vol. 16(1), pages 8-37, 03.
  13. Branco, Fernando, 2002. "Procurement favouritism and technology adoption," European Economic Review, Elsevier, vol. 46(1), pages 73-91, January.
  14. Michael H. Rothkopf, 1991. "On Auctions with Withdrawable Winning Bids," Marketing Science, INFORMS, vol. 10(1), pages 40-57.
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