Bunching with Price Regulation

Francesca Stroffolini

Rivista italiana degli economisti, 2002, issue 1, 127-140

Abstract: This paper tackles the problem of the regulation of a monopolistic firm under asymmetric information in the form of adverse selection on the technological parameter when the regulator is "legally prevented from transferring money to the firm and when the firm charges a linear tariff in quantity". In the absence of transfers, the optimal price mechanism might not be able to offer additional information about the type of firm and, therefore, could involve the offer of the same price to different types of firm (bunching). This paper focuses on this and, more particularly, it studies the sufficient conditions under which bunching arises in the discrete case. In the absence of government's transfers and with a linear pricing system the possibility of bunching arises from the fact that the absolute level of prices is set to satisfy the balanced budget constraint of the firm; in other words, the rent that has to be granted to the efficient type firm can only be obtained from a greater revenue which, in the relevant range, requires a higher level of equilibrium price. It follows that the couple of contracts offered to the firm entails that the optimal effort requested from the efficient type becomes a decreasing function, through the rent, of the optimal level of effort requested from the inefficient one; furthermore, the shadow cost of the firm's reward, which is the deadweight loss of the consumer price increase with respect to the marginal cost, associated with the increase in reward, results endogenously determined and firm's type contingent. One result of our paper that is worth emphasizing is that bunching is more likely to occur when the priceelasticity of demand (in absolute terms) is low: i.e., especially in the case of "necessary goods" which are those mainly consumed by low-income people.

Date: 2002
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