A Theory of Yardstick Competition

Andrei Shleifer

RAND Journal of Economics, 1985, vol. 16, issue 3, 319-327

Abstract: In the typical regulatory scheme a franchised monopoly has little incentive to reduce costs. This article proposes a mechanism in which the price the regulated firm receives depends on the costs of identical firms. In equilibrium each firm chooses a socially efficient level of cost reduction. The mechanism generalizes to cover heterogeneous firms with observable differences. Medicare's prospective reimbursement of hospitals by using diagnostically related groups is a scheme very similar to the one outlined here.

Date: 1985
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