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Regulation of non-marketed outputs and substitutable inputs

Author

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  • Bertsch, Joachim

    (Energiewirtschaftliches Institut an der Universitaet zu Koeln (EWI))

  • Hagspiel, Simeon

    (Energiewirtschaftliches Institut an der Universitaet zu Koeln (EWI))

Abstract

We study the regulation of a monopolistic firm that provides a non-marketed output based on multiple substitutable inputs. The regulator is able to observe the effectiveness of the provision, but faces information asymmetries with respect to the efficiency of the firm’s activities. Motivated by the example of electricity transmission services, we consider a setting where one input (grid expansion) and the output (uninterrupted electricity transmission) are observable, while another input(sophisticated grid operation) and related costs are not. Multi-dimensional information asymmetries are introduced by discrete distributions for the functional form of the marginal rate of substitution between the inputs as well as for the input costs. For this novel setting, we investigate the theoretically optimal Bayesian regulation mechanism. We find that the first best solution cannot be obtained in case of shadow costs of public funding. The second best solution implies separation of the most efficient type with first best input levels, and upwards distorted (potentially bunched)observable input levels for all other types. Moreover, we compare these results to a simpler on-Bayesian approach and hence, bridge the gap between the academic discussion and regulatory practice. We provide evidence that under certain conditions, a single contract on-Bayesian regulation can indeed get close to the second best of the Bayesian menu of contracts regulation.

Suggested Citation

  • Bertsch, Joachim & Hagspiel, Simeon, 2015. "Regulation of non-marketed outputs and substitutable inputs," EWI Working Papers 2015-6, Energiewirtschaftliches Institut an der Universitaet zu Koeln (EWI).
  • Handle: RePEc:ris:ewikln:2015_006
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    References listed on IDEAS

    as
    1. David Sappington, 1983. "Optimal Regulation of a Multiproduct Monopoly with Unknown Technological Capabilities," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 453-463, Autumn.
    2. B. Caillaud & R. Guesnerie & P. Rey & J. Tirole, 1988. "Government Intervention in Production and Incentives Theory: A Review of Recent Contributions," RAND Journal of Economics, The RAND Corporation, vol. 19(1), pages 1-26, Spring.
    3. Armstrong, Mark, 1999. "Optimal Regulation with Unknown Demand and Cost Functions," Journal of Economic Theory, Elsevier, vol. 84(2), pages 196-215, February.
    4. Paul L. Joskow, 2014. "Incentive Regulation in Theory and Practice: Electricity Distribution and Transmission Networks," NBER Chapters, in: Economic Regulation and Its Reform: What Have We Learned?, pages 291-344, National Bureau of Economic Research, Inc.
    5. Myerson, Roger B, 1979. "Incentive Compatibility and the Bargaining Problem," Econometrica, Econometric Society, vol. 47(1), pages 61-73, January.
    6. Richard Schmalensee, 1989. "Good Regulatory Regimes," RAND Journal of Economics, The RAND Corporation, vol. 20(3), pages 417-436, Autumn.
    7. Armstrong, Mark & Porter, Robert, 2007. "Preface to the Handbook of Industrial Organization, Volume 3," Handbook of Industrial Organization, in: Mark Armstrong & Robert Porter (ed.),Handbook of Industrial Organization, edition 1, volume 3, chapter 0, pages 00, Elsevier.
    8. 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.
    9. Mark Armstrong & Robert Porter (ed.), 2007. "Handbook of Industrial Organization," Handbook of Industrial Organization, Elsevier, edition 1, volume 3, number 1, 00.
    10. Dana Jr. James D., 1993. "The Organization and Scope of Agents: Regulating Multiproduct Industries," Journal of Economic Theory, Elsevier, vol. 59(2), pages 288-310, April.
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    More about this item

    Keywords

    regulation; asymmetric information; mechanism design; non-marketed goods; substitutable inputs; electricity transmission;

    JEL classification:

    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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