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Regulating a Monopolist through Capacity Control

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  • Dihan Zou

Abstract

We study monopoly regulation when capacity is contractible but subsequent output is not. A firm privately observes its production cost before installing costly capacity and then choosing output, while the regulator cannot use transfers. We provide sufficient conditions under which a single capacity floor implements an optimal mechanism with full participation. The floor raises output by changing investment while leaving utilization to the firm after installation costs are sunk. Under additional conditions, the allocation has three regions: laissez-faire, full utilization of the floor, and underutilization. High-cost types knowingly install capacity they will not fully use, yet produce more than under laissez-faire. This physical waste is a necessary evil of optimal regulation that expands service. We also show that underutilization can persist in optimal regulation with capacity-contingent subsidies or a common entry fee.

Suggested Citation

  • Dihan Zou, 2026. "Regulating a Monopolist through Capacity Control," Papers 2610.07189, arXiv.org, revised Oct 2026.
    • Handle: RePEc:arx:papers:2610.07189
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    References listed on IDEAS

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    1. Zi Yang Kang, 2026. "Prices vs. Quantities: Robust Regulation," Papers 2603.15832, arXiv.org, revised Sep 2026.
    2. Javier Gonzalez Morin & David Martimort, 2026. "On The (Relative) Merits of Money Burning For Optimal Contracting," Working Papers hal-05601560, HAL.
    3. Manuel Amador & Kyle Bagwell, 2013. "The Theory of Optimal Delegation With an Application to Tariff Caps," Econometrica, Econometric Society, vol. 81(4), pages 1541-1599, July.
    4. Osmundsen, Petter, 2002. "Regulation of common property resources under private information about resource externalities," Resource and Energy Economics, Elsevier, vol. 24(4), pages 349-366, November.
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