Thus, the PDPO over-invests in e relative to the social optimum.
Also, i is lower under the statutory arrangement in comparison with the PDPO as long as [[lambda].sup.S] < 1; [i.sup.S*] < [i.sup.P*] < i * when [[lambda].sup.S] < 1 but [i.sup.S*] = [i.sup.P*] when [[lambda].sup.S] = 1.
The PDPO is unambiguously superior to the SDPO when:
In the first case, the PDPO has stronger incentives to cut cost while the offsetting impact of quality degradation is small.
But, when the incentive to innovate is strong ([[lambda].sup.S] [right arrow] 1), the SDPO may be just as motivated as the PDPO to improve service quality.
Costs are always lower in the case of PDPO as it devotes socially excessive effort to cost reduction, [e.sup.S*] < e* < [e.sup.P*] (see Proposition 1).
Overall, the PDPO has a tendency to overinvest in cost saving innovation, [e.sup.P*] > e*, and a tendency to under-invest in service quality improvement, [i.sup.P*] < i*.
At best, [M.sup.S] may engage in quality innovation similar to that of the PDPO, [i.sup.S*] = [i.sup.P*] and [[lambda].sup.S]= 1.
But, periodically auctioning off the PDPO to the highest bidder could create scope for at least some competition for the market and a degree of contestability in provider-customer relations.
First, envisaging the PDPO as a conventional commercial entity exposed to the commercial pressures of the market place helps us analyze the implications of imposing commercial discipline on its trading activities.
In short, G may assign the SDPO objectives that are at variance with those of D and, thus, the relationship between D and the SDPO could come to look more like that between D and the PDPO.
When the procurement function is contracted out, the PDPO is auctioned through a competitive market so that its new (private) owner pays the auction price equal to the expected profits of the now private entity (Schmidt 1996a).