EEG UMinho & Online
Luís is currently a Postdoctoral Research Fellow in Economics in the Centre for Research in Economics and Management (U. Minho, Portugal). He holds a PhD in Economics from that same university, and his research interests lie in the boundary between the Theory of Industrial Organisation and Health Economics.
When the quality of a product is imperfectly observable and consumers evaluate it idiosyncratically, firms’ “average quality” is generally suboptimal. Policymakers might promote quality provision by granting consumers more precise information, thus increasing firms’ marginal benefit from quality investments, but this generally comes at the cost of higher prices. In this article, I study the consequences of depriving firms of their ability to adjust prices through regulation, and focus on the interplay between informational precision and suboptimal yet feasible price regulation.
In a model of horizontally differentiated duopolists, the utility consumers derive from either product is the realisation of a random variable with mean equal to the firm’s quality investment (its “average quality”). Consumers perfectly observe prices and a noisy signal about their idiosyncratic valuations before consumption. The healthcare and higher education industries are clear-cut applications of this framework.
I start by showing that, in the unregulated market, increased informational precision (i.e., a lower variance of consumers’ signals) always leads to higher quality, but its impact on the price depends on whether the firms’ technology exhibits cost substitutability or complementarity between quality and output.
I then explore three forms of price regulation when the regulator is unable to set a price sufficiently high to elicit first-best quality. If the regulated price is approximately equal to the market price, the regulator always faces a trade-off between the magnitude of the change in quality elicited by better information and the absence of price adjustments, relative to the unregulated benchmark. If the regulated price is greater than the market price, quality and total welfare are unambiguously higher. Although consumers may be worse off than without regulation, the political economy of further price increases is facilitated when these are accompanied by more precise information. Finally, a prospectively bargained regulated price is suboptimal and leaves the effect of informational precision unchanged.
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