DP8284 Quality competition with profit constraints: Do non-profit firms provide higher quality than for-profit firms?

Author(s): Kurt Richard Brekke, Luigi Siciliani, Odd Rune Straume
Publication Date: March 2011
Keyword(s): Profit constraints, Quality competition, Semi-altruistic providers
JEL(s): D21, D43, L13, L30
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8284

In many markets, such as education, health care and public utilities, firms are often profit-constrained either due to regulation or because they have non-profit status. At the same time such firms might have altruistic concerns towards consumers. In this paper we study semi-altruistic firms? incentives to invest in quality and cost-reducing effort when facing constraints on the distribution of profits. Using a spatial competition framework, we derive the equilibrium outcomes under both quality competition with regulated prices and quality-price competition. Profit constraints always lead to lower cost-efficiency, whereas the effects on quality and price are ambiguous. If altruism is high (low), profit-constrained firms offer higher (lower) quality and lower (higher) prices than firms that are not profit-constrained. Compared with the first-best outcome, the cost-efficiency of profit-constrained firms is too low, while quality might be over- or underprovided. Profit constraints may improve welfare and be a complement or substitute to a higher regulated price, depending on the degree of altruism.