The dyadic subsidy game: Effects of uncertain and changing subsidies on price setting

In order to reduce sales (production) of environmentally harmful products we investigate the effects of subsidies that compensate producers for what they do not sell. A repeated duopoly price-setting game with imperfect price competition was devised. The results show that higher subsidies led to reduced sales and, as a consequence, higher price, and that uncertainty regarding the size of the subsidy did not change this. Furthermore, competition was not eroded by introducing the subsidy. The results also indicate that the theoretical framework of dyadic price negotiation is applicable to the dyadic subsidy game. We conclude that such a subsidy system may be used as a regulating mechanism in order to reduce sales (and thereby production) of environmentally harmful products or as a tool to restrain the overharvesting of finite resource