Mixed Oligopoly with Distortions: First Best with Budget-balance and the Irrelevance Principle

This paper extends the literature on mixed oligopoly in two directions. First, it introduces distortions in the working of the public firm, an issue that is of some concern, especially in transitional economies. Thus the classical model of mixed oligopoly emerges as a special case of our formulation. Second, we examine the implementation of the first best outcome in the presence of budget balancing. We show that as long as such distortions are not too severe, these do not prevent the implementation of the first best outcome with budget balancing, with the first best policy involving a tax on the public firm, coupled with subsidies to the private firms. Further, in the absence of any distor tions, implementing the first best with budget balancing necessarily involves complete socialization. This shows the importance of budget balancing to the applicability of the irrelevance principle.