Monopolio

Regulating a Monopolist with Unknown Costs Author(s): David P. Baron and Roger B. Myerson Source: Econometrica, Vol. 50, No. 4, (Jul., 1982), pp. 911-930 Published by: The Econometric Society Stable URL: http://www.jstor.org/stable/1912769 Accessed: 20/04/2008 21:32
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Econometrica,Vol. 50, No. 4 (July, 1982)

REGULATING A MONOPOLIST WITH UNKNOWN COSTS
BY DAVID P. BARON AND ROGER B. MYERSON1 We consider the problem of how toregulate a monopolistic firm whose costs are unknown to the regulator. The regulator's objective is to maximize a linear social welfare function of the consumers' surplus and the firm's profit. In the optimal regulatory policy, prices and subsidies are designed as functions of the firm's cost report so that expected social welfare is maximized, subject to the constraints that the firm has nonnegativeprofit and has no incentive to misrepresent its costs. We explicitly derive the optimal policy and analyze its properties.

1. INTRODUCTION IN THEIR CLASSIC PAPERS Dupuit [2] and Hotelling [5] considered pricing policies for a bridge that had a fixed cost of construction and zero marginal cost. They demonstrated that the pricing policy that maximizes consumer well-being is to set price equal tomarginal cost and to provide a subsidy to the supplier equal to the fixed cost, so that a firm would be willing to provide the bridge. This first-best solution is based on a number of informational assumptions. First, the demand function is assumed to be known to both the regulator and to the firm. While the assumption of complete information may be too strong, the assumption that informationabout demand is as available to the regulator as it is to the firm does not seem unnatural. A second informational assumption is that the regulator has complete information about the cost of the firm or at least has the same information about cost as does the firm. This assumption is unlikely to be met in reality, since the firm would be expected to have better information about costs than would theregulator. As Weitzman has stated, "An essential feature of the regulatory environment I am trying to describe is uncertainty about the exact specification of each firm's cost function. In most cases even the managers and engineers most closely associated with production will be unable to precisely specify beforehand the cheapest way to generate various hypothetical output levels. Because they areyet removed from the production process, the regulators are likely to be vaguer still about a firm's cost function" [12, p. 684].

As this observation suggests, it is natural to expect that a firm would have better information regarding its costs than would a regulator. The purpose of this paper is to develop an optimal regulatory policy for the case in which the regulator does not know the...