The Informative Role of Subsidies

This paper investigates the effect of monopoly subsidies on entry deterrence. We consider a potential entrant who observes two signals: the subsidy set by the regulator and the output level produced by the incumbent firm. We show that not only an informative equilibrium can be supported, where information about the incumbent's costs is conveyed to the entrant, but also an uninformative equilibrium, where the actions of regulator and incumbent conceal the monopolist's type, thus deterring entry. While the regulator?s role can support entry-deterrence practices, we demonstrate that his presence is nonetheless welfare improving. Furthermore, we compare equilibrium welfare relative to two benchmarks: complete information environments, and standard entry-deterrence games where the regulator is absent.