Economic Policy, Problem 3-1,Exercise sheet 3: Interest Groups and Special-Interest Politics

Consider 2 energy companies competing for the rights on the oil from a newly discovered oil source. Both are considering to use lobbying in order to increase the probability of obtaining the rights θ . The expected profit functions of the firms A and B are given as follows:  

where LA and LB represent the lobbying investments and R is the expected profit from the oil source. Assume that the firm A leads by choosing the investment LA and the firm B follows with an investment LB . The probability that the firm A wins the rent-seeking contest is given by: A BAL LLαθ+ = where α <1 implies that the first player’s investments are more effective than those of the second and α >1 implies the reverse.

a) Determine the optimal lobbying investments as well as the resulting expected profits for each firm! 

b) Comment on the role of the investment effectiveness α with respect to the fact of being leader or follower!