Efficient Competition with Small Numbers

This paper studies competition between a small number of suppliers and a single buyer (or an auction with a small number of bidders and a single seller), when total demand (supply) is uncertain. It is well known that when a small number of suppliers compete in supply functions the service is not provided efficiently. We show that production efficiency is obtained if suppliers compete in simple two-part bid functions. However, profits are not eliminated. Moreover, the buyers' (sellers') decision regarding how much to buy is not efficient. We also show that suppliers (bidders in an auction) always have an incentive to merge (form bidding rings) in this setting.