Regulation of a vertically differentiated duopoly

Abstract

This paper focuses on the optimal quality regulation of vertically differentiated duopolies in the presence of asymmetric information. In the model presented there are cross-effects on the information rent. Contrary to standard single-agent models, the production levels are distorted in favour of the most efficient firm, whose production level is increased under asymmetric information relative to full information. The first-best outcomes can only be achieved if both firms are of the most efficient types. The optimal degree of vertical differentiation is also discussed. Furthermore, some extensions to the model are examined (the presence of cost complementarity, quality as complements etc.).