Competition and Quality in Regulated Markets: A Differential-Game Approach

36 Pages Posted: 12 Jun 2008  

Kurt Richard Brekke

Norwegian School of Economics (NHH) - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Roberto Cellini

University of Catania - Department of Economics and Business

Luigi Siciliani

University of York

Odd Rune Straume

University of Minho - Economic Policies Research Unit (NIPE); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: April 2008

Abstract

We investigate the effect of competition on quality in regulated markets (e.g., health care, higher education, public utilities) taking a differential game approach, in which quality is a stock variable. Using a Hotelling framework, we derive the open-loop solution (providers commit to an optimal investment plan at the initial period) and the feedback closed-loop solution (providers move investments in response to the dynamics of the states). If the marginal provision cost is constant, the open-loop and closed-loop solutions coincide, and the results are similar to the ones obtained by static models. If the marginal provision cost is increasing, investment and quality are lower in the closed-loop solution: in fact, quality drops to the minimum level in steady state, implying that quality competition is effectively eliminated. In this case, static models tend to exaggerate the positive effect of competition on quality. Our results can explain the mixed empirical evidence on competition and quality for regulated markets.

Keywords: Competition, Quality, Regulated markets

JEL Classification: H42, I11, I18, L13

Suggested Citation

Brekke, Kurt Richard and Cellini, Roberto and Siciliani, Luigi and Straume, Odd Rune, Competition and Quality in Regulated Markets: A Differential-Game Approach (April 2008). , Vol. , pp. -, 2008. Available at SSRN: https://ssrn.com/abstract=1143164

Kurt Richard Brekke (Contact Author)

Norwegian School of Economics (NHH) - Department of Economics ( email )

Helleveien 30
N-5035 Bergen
Norway

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Roberto Cellini

University of Catania - Department of Economics and Business ( email )

Corso Italia 55
95129 Catania, 95129
Italy
+390957537728 (Phone)
+390957537710 (Fax)

Luigi Siciliani

University of York ( email )

Heslington
York, YO10 5DD
United Kingdom

Odd Rune Straume

University of Minho - Economic Policies Research Unit (NIPE) ( email )

Campus de Gualtar
Braga, 4710-057
Portugal

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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