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Price Regulation and Quality of Service

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  • Morton I. Kamien
  • Daniel R. Vincent
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    Abstract

    Public concern has been rising about whether market forces are sufficient to ensure the optimal choice of quality of services. We examine a model in which unregulated competition leads to an underprovision of quality from a social perspective and then study the effects of price regulation. Although price floors sometimes have the expected effect of increasing the incentives to raise the quality of services, their imposition changes the nature of competitive behaviour in subtle ways and often changes the relative positions of firms in the market. We show that no price floor exists which will achieve the socially optimal quality choice and the only price floors that result in symmetric firm behaviour are those which involving an overinvestment in quality. We also examine the effects of imperfect consumer information about quality under various consumer learning processes and find that slow but plausible learning behavior can lead to an increase in quality. We also show that firms typically benefit from consumers' uncertainty about the quality of both their own good and their rival's. Informative advertising about the firm's or its rival's product is not in the firm's best interest.

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    File URL: http://www.kellogg.northwestern.edu/research/math/papers/920.pdf
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    Bibliographic Info

    Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 920.

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    Date of creation: Feb 1991
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    Handle: RePEc:nwu:cmsems:920

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    Web page: http://www.kellogg.northwestern.edu/research/math/
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    1. Mitchell, Mark L & Maloney, Michael T, 1989. "Crisis in the Cockpit? The Role of Market Forces in Promoting Air Travel Safety," Journal of Law and Economics, University of Chicago Press, vol. 32(2), pages 329-55, October.
    2. Grossman, Sanford J, 1981. "The Informational Role of Warranties and Private Disclosure about Product Quality," Journal of Law and Economics, University of Chicago Press, vol. 24(3), pages 461-83, December.
    3. Chalk, Andrew J, 1987. "Market Forces and Commercial Aircraft Safety," Journal of Industrial Economics, Wiley Blackwell, vol. 36(1), pages 61-81, September.
    4. D. Mark Kennet, 1993. "Did Deregulation Affect Aircraft Engine Maintenance? An Empirical Policy Analysis," RAND Journal of Economics, The RAND Corporation, vol. 24(4), pages 542-558, Winter.
    5. Borenstein, Severin & Zimmerman, Martin B, 1988. "Market Incentives for Safe Commercial Airline Operation," American Economic Review, American Economic Association, vol. 78(5), pages 913-35, December.
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    Cited by:
    1. Martin Gaynor, 2006. "What Do We Know About Competition and Quality in Health Care Markets?," NBER Working Papers 12301, National Bureau of Economic Research, Inc.
    2. Asher Wolinsky, 1994. "Regulation of Duopoly: Managed Competition vs. Regulated Monopolies," Discussion Papers 1116, Northwestern University, Center for Mathematical Studies in Economics and Management Science.

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