Coordinating Pricing and Supply of Public Interest Goods Using Government Rebates and Subsidies

Abstract

This paper presents a stylized framework for analyzing the design of government incentives for public interest goods (goods with externalities, such as electric vehicles.) We extend the newsvendor model with pricing to account for the consumption externality inherent in public interest goods and analyze the governments ability to coordinate their pricing and supply through the use of rebates and subsidies. Our model allows for goods with both positive and negative externalities, and considers three government intervention mechanisms: the joint mechanism that uses both subsidies and rebates, and two simplified mechanisms that use only rebates or only subsidies. The goal of the intervention is to coordinate the system in order to achieve the maximal welfare, which in our model consists of the firms profit, consumer surplus, and externality benefit net the government cost. We find that the joint mechanism coordinates the system, but results in a negative subsidy (i.e., a tax) unless the externality is very small. The simplified mechanisms mostly result in positive rebates and subsidies, but generally do not coordinate the system. We apply our model to the case of Chevy Volt, a leading electric vehicle in North America manufactured by General Motors. We estimate all model parameters from industry data and present a comprehensive numerical study that compares the current government incentives with those suggested by our model. We find that while the current incentives are structurally suboptimal, the resultant welfare loss under the rebate-only mechanism is very small, while under the subsidy-only mechanism it is quite large.

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