Bigger and Better: A Dynamic Regulatory Mechanism for Optimum Quality

Gianni De Fraja () and Alberto Iozzi ()

No 4502, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Vogelsang and Finsinger’s seminal paper (Bell Journal of Economics, 1979) proposes a mechanism for price regulation with some desirable properties, such as convergence to a second best optimum. This mechanism applies to situations where quality is fixed: in practice, quality can be varied by the firm, and regulators have typically imposed constraints on the firm’s quality choice. This Paper lays a rigorous theoretical foundation to the inclusion of quality measures in the constraints faced by a regulated firm. We identify a potential pitfall in the approach taken in practice by regulators, and show that, in order to avoid it, the regulated firm should be subject to an additional constraint, which, loosely speaking, requires firms’ choices not to be too erratic.

Keywords: price cap; quality; regulation; RPI-X (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ind, nep-mic, nep-pbe and nep-reg
Date: 2004-08
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