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Competition and quality in regulated markets: a differential-game approach

Brekke, Kurt Richard; Straume, Odd Rune; Siciliani, Luigi; Cellini, Roberto
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URI
http://hdl.handle.net/11250/163120
Date
2008-02
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  • Discussion papers (SAM) [578]
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 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, implying that static models are robust to a dynamic specification. 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.
Publisher
Norwegian School of Economics and Business Administration. Department of Economics
Series
Discussion paper
2008:3

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