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: cepr.org/active/publications/discussion_papers/dp.php?dpno=6938

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.