Government subsidies for preventing supply disruption when the supplier has an outside option under competition

Abstract To prevent supply a disruption caused by capacity constraints and outside options, the government needs to offer subsidies. The following two types of subsidies are investigated: subsidies to the supplier (Mode S) and subsidies to the manufacturers (Mode M). Our analysis reveals that government subsidy strategies depend on the size of the external price and the capacity. Interestingly, Mode M (manufacturer subsidy) is superior to Mode S (supplier subsidy). Moreover, subsidizing both the supplier and manufacturers simultaneously is not superior to a single subsidy mode. Furthermore, the social welfare in the competitive case is not worse than that in the monopoly case under certain conditions. However, neither subsidy mode can prevent supply disruptions under scenarios of higher intensity of competition.