Deregulation and quality

This paper analyses, within a static model, the effect of quality concern on optimal market structure. It focuses on cases where industry quality has public-good like features and is not contractible. It is shown that the introduction of competition raises a free-rider problem which depresses quality (the smaller producer free-rides on its competitor investment which as a result underinvests). To encourage the efficient producer to provide quality, the regulator diminishes the market-share of the opportunistic producer and chooses more often a monopoly. However, when quality is verifiable the introduction of competition entails no welfare loss whether the regulator observes total quality outcome or individual contributions. (C) 1998 Elsevier Science B.V.