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Dynamic Yardstick Competition as a Mean Field Game: Explicit Theory with OU, CIR, and GBM Cost Dynamics

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  • Heng-fu Zou

Abstract

This paper embeds yardstick competition in a dynamic mean field a mean game (MFG) framework to analyze the regulation of industries with a continuum of cost-reducing firms. Each firm faces a stochastic cost process -- modeled explicitly as Ornstein-Uhlenbeck (OU), Cox-Ingersoll-Ross(CIR), or Geometric Brownian Motion(GBM)-and chooses continuous-time effort to lower cost. A regulator sets each firm's price equal to the contemporaneous mean cost of the population. We formulate and solve the coupled Hamilton-Jacobi-Bellman and Fokker-Planck system describing this economy, prove existence and uniqueness of equilibrium using the Lasry-Lions monotonicity framework, and show that the yardstick mech anism achieves the social first best in closed form. For each diffusion process we derive fully explicit formulas for equilibrium effort, mean cost paths, adjustment speeds, and welfare, allowing complete comparative statics and shock analysis without numerical simulation. The model pro- vides a tractable and policy-ready extension of Shleifer's (1985) original insight, demonstrating that yardstick competition yields robust, efficient incentives even in large dynamic industries subject to stochastic shocks.

Suggested Citation

  • Heng-fu Zou, 2025. "Dynamic Yardstick Competition as a Mean Field Game: Explicit Theory with OU, CIR, and GBM Cost Dynamics," CEMA Working Papers 796, China Economics and Management Academy, Central University of Finance and Economics.
    • Handle: RePEc:cuf:wpaper:796
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    References listed on IDEAS

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    1. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, December.
    2. Andrei Shleifer, 1985. "A Theory of Yardstick Competition," RAND Journal of Economics, The RAND Corporation, vol. 16(3), pages 319-327, Autumn.
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