The Interdependence between Ownership Status and Market Structure: The Case of Privatization

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Abstract

One of the common justifications for privatization policy is the assertion that private firms are more efficient and thus potentially more profitable. The analysis of privatization policy, however, cannot be complete without specific attention to the market structure in which the firm operates and in particular to the interdependence between the ownership status and market structure. I examine a dupolistic market and demonstrate that a partly nationalized firm might realize higher profits than its private, profit-maximizing, competitor. The degree of nationalization also affects the interaction between an incumbent firm and a potential entrant. Using A. K. Dixit's framework, I consider the implications of privatization on the attractiveness of entry, the possibility of deterring entry, and the incumbent position as a natural monopoly. It is shown that it is possible that a firm is not a natural monopoly while being private but that alteration of its ownership status can transform it to a natural monopoly. Such an analysis establishes my main claim that ownership status may affect the market structure in which firms operate.

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