Regulation of non-marketed outputs and substitutable inputs

Joachim Bertsch () and Simeon Hagspiel
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Joachim Bertsch: ewi Energy Research & Scenarios
Simeon Hagspiel: University of Cologne

Journal of Regulatory Economics, 2018, vol. 53, issue 2, No 3, 174-205

Abstract: Abstract We study the regulation of a monopolistic firm that provides a non-marketed output based on multiple substitutable inputs. The regulator is able to observe the effectiveness of the provision, but faces information asymmetries with respect to the efficiency of the firm’s activities. Specifically, we consider a setting where one input and the output are observable, while another input and related costs are not. Multi-dimensional information asymmetries are introduced by discrete distributions for the functional form of the marginal rate of substitution between the inputs as well as for the input costs. For this novel setting, we investigate the theoretically optimal Bayesian regulation mechanism. We find that the first-best solution cannot be obtained in case of shadow costs of public funding. The second-best solution implies separation of the most efficient type with first-best input levels, and upwards distorted (potentially bunched) observable input levels for all other types. Moreover, we compare these results to a simpler non-Bayesian approach, i.e., a single pooling contract, and hence, bridge the gap between the academic discussion and regulatory practice. In a numerical simulation, we identify certain conditions in which a single contract non-Bayesian regulation can indeed get close to the second-best solution of the Bayesian menu of contracts regulation.

Keywords: Regulation; Asymmetric information; Mechanism design; Non-marketed goods; Substitutable inputs (search for similar items in EconPapers)
JEL-codes: D42 D82 L51 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1007/s11149-017-9348-4

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