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Cost-efficiency and quality regulation of a public utility

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  • Marten Ovaere

Abstract

This paper studies the effect of linear cost-efficiency and quality regulation of a public utility on its cost-reducing effort and its provided quality level. The analysis shows that a quality incentive increases both quality and effort, while a cost-efficiency incentive increases effort and decreases quality. Next, introducing uncertainty and asymmetric information, I show that the power of the cost-efficiency and quality incentive should optimally be equal and below one. The incentive powers decrease with increasing uncertainty and increasing dislike for public utility profit. Last, we analyze case studies in electricity, gas and water. As in most cases the power of the quality incentive is higher than the power of the cost-efficiency incentive, the model predicts that supplied quality is too high.

Suggested Citation

  • Marten Ovaere, 2017. "Cost-efficiency and quality regulation of a public utility," Working Papers of Department of Economics, Leuven 606626, KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven.
    • Handle: RePEc:ete:ceswps:606626
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