Working Paper: CEPR ID: DP6938
Authors: Kurt Richard Brekke; Roberto Cellini; Luigi Siciliani; Odd Rune Straume
Abstract: We investigate the effect of competition on quality in regulated markets (e.g., health care, higher education, public utilities), using a Hotelling framework, in the presence of sluggish demand. We take a differential game approach, and 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 cost of provision is increasing, the steady state quality is higher under the open-loop solution than under the closed-loop solution. Fiercer competition (lower transportation costs and/or less sluggish demand) leads to higher quality in both solutions, but the quality response to increased competition is weaker when players use closed-loop strategies. In both solutions, quality and demand move in opposite directions over time on the equilibrium path to the steady state.
Keywords: competition; quality; regulated markets
JEL Codes: H42; I11; I18; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| marginal cost of provision increasing (D61) | steady-state quality higher under open-loop solution (L15) |
| fiercer competition (lower transportation costs or less sluggish demand) (L11) | higher quality (L15) |
| closed-loop strategies (L21) | weaker quality response to increased competition (L15) |
| quality and demand move in opposite directions over time (L15) | contradicts static relationship (C69) |
| higher prices and lower transportation costs (R48) | higher quality in steady state (L15) |
| closed-loop solution (C69) | lower quality than open-loop solution when marginal costs are increasing (D43) |