Regulation of Duopoly Under Asymmetric Information: Prices VS Quantities

Asher Wolinsky

No 1061, Discussion Papers from Northwestern University, Center for Mathematical Studies in Economics and Management Science

Abstract: This paper discusses the regulation of oligopolistic differentiated product industries under conditions of incomplete information. The regulator can control the prices, and impose quantity restrictions, but cannot control effectivelythe quality choices of the firms. We inquire about the optimal choice of instruments by the regulators--whether and under what conditions the regulation of prices or quantities achieves better results. In the spatial duopoly model analyzed here uninterrupted competitoin will generally result in an inefficient allocation. When the regulator knows the technologies, optimal price regulation results in distortions of the quality choice, but optimal price regulation results in distrotions of the outcome. When the regulator is uncertain about the technologies neither of these methods willyield the first best outcome. We characterize the optimal regulation problems for these two methods, and solve explicityly two specifci examples. The method of price regulation tends tobe more effective at extracting rents from the first, while regulation of quantities (assignment of monopoly areas) tends to produce better quality choices. The overall comparison depends on some finer details of the environment. If in the quality competition stage the firms still do not know each other's costs, quantity regulation (assignemnt of local monopoly rights) performs better. If in that stage they learn ech other's costs, either of the two methods might perform better. Quantity regulation will still be somestims superior, but in contrast to the complete information environment, price regulation will also be sometims supoerior. With other things equal, the latter will tend to happen when the regulator assigns relatively higher priority to rent extraction.

Date: 1993-08
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