Monopoly Regulation Under Incomplete Information: Prices vs. Quantities

In this paper we compare two mechanisms to regulate a monopoly: fixing a price for the good or service, or fixing the quantity to be produced. We consider an environment of asymmetric information in which the regulated firm has private information about the demand it faces or its costs. We completely characterize the optimal mechanism in both case and compare their performance. The problem is solved considering a (sophisticated) mechanism design approach, and also an environment where (simple) bunching mechanism must be used. When demand is known imperfectly by the regulator, and he is allowed to choose any mechanism, price regulation dominates quantity regulation for increasing marginal costs, while simple price bunching regulation dominates for decreasing marginal costs. In the remaining cases, price and quantity regulation can both be preferable, depending on parameter values. In particular, for sophisticated regulation and decreasing marginal cost, the importance the regulator gives to monopoly profits play a major role.