There are several industries in which a regulated firm owns an input which is both essential for production, and prohibitively costly to duplicate. A third party planning to compete with the regulated firm needs therefore to purchase this input from its product market competitor. This poses the regulators of such industries a dilemma between competition and efficiency: leaving the determination of the price for the use of this input to its owners may tempt them to set a price so high that no firm would ever want to compete, while choosing too low a price may encourage inefficient competitors to operate instead of the more efficient monopoly network owner.

In Discussion Paper No. 1122, Research Affiliate Gianni De Fraja modifies the Laffont-Tirole model of regulation to investigate whether it is socially optimal for the price of access to be set in such a way as to entrust production to the most efficient supplier. He finds that in the presence of asymmetric information, it is not; indeed, it is optimal to take a `pro-competitive' stance in access pricing, following a policy which implies that the less efficient entrant supplies the final market, provided the difference in efficiency between the network owner and the entrant is not too wide. While with symmetric information, the most efficient firm supplies the final market, the paper vindicates the `gut feeling' of antitrust practitioners that there is a case for imposing a lower access price than would be required on efficiency grounds alone, even when this implies subsidizing a less efficient producer. A consequence of the fact that it is optimal to bias the access price against the regulated firm is that it is not possible to delegate the access pricing decision: there is a genuine loss in welfare if the access price is left to negotiation between the parties.

Regulation and Access Pricing with Asymmetric Information
Gianni De Fraja

Discussion Paper No. 1122, January 1995 (IO)