Would excess capacity in public firms be socially optimal?

We analyse oligopolistic interactions between a welfare-maximizing public f irm and a profit-maximizing private firm in a repeated game. We find that t he public firm can hold excess capacity as a strategic punishment device to sustain a subgame perfect equilibrium which is welfare-superior to the sta tic Nash equilibrium. Basically, potential punishment from the public firm in the dynamic game can make the self-interested private firm behave in the public interest. Furthermore, if capacity is endogenous, public excess cap acity can occur in a welfare efficient equilibrium when the cost of public capacity investment is higher than that of private investment.