Partial Regulation in Vertically Differentiated Industries

Abstract

In this paper we provide theoretical foundations for a price-and-quality cap regulation of recently liberalized utilities. We model a partially regulated oligopoly where vertically differentiated services are provided by a regulated incumbent and an unregulated entrant competing in price and quality. The model may equally well represent competition within or across industries. We establish that weights in the cap need to depend also on the market served by the entrant, despite the latter is not directly concerned by regulation. This calls for the possibility that regulators use information about the whole industries, rather than on the sole incumbent. In the unit demand case, however, regulation can be conducted as if the regulated firm were still a monopoly.