DP6938 Competition and quality in regulated markets with sluggish demand

Author(s): Kurt Richard Brekke , Roberto Cellini , Luigi Siciliani , Odd Rune Straume

Publication Date: August 2008

Keyword(s): competition , quality , Regulated markets

JEL(s): H42 , I11 , I18 , L13

Programme Areas: Industrial Organization

Link to this Page: www.cepr.org/pubs/dps/DP6938.asp.asp

We investigate the effect of competition on quality in regulated markets (e.g., health care, higher education, public utilities), using a Hotelling framework, in the presence of sluggish demand. We take a differential game approach, and derive the open-loop solution (providers commit to an optimal investment plan at the initial period) and the feedback closed-loop solution (providers move investments in response to the dynamics of the states). If the marginal cost of provision is increasing, the steady state quality is higher under the open- loop solution than under the closed-loop solution. Fiercer competition (lower transportation costs and/or less sluggish demand) leads to higher quality in both solutions, but the quality response to increased competition is weaker when players use closed-loop strategies. In both solutions, quality and demand move in opposite directions over time on the equilibrium path to the steady state.