Monopoly, Quality, and Regulation

This paper deals with market problems that arise when a monopoly sets some aspect of product quality as well as price. It is argued that the market failure is associated with the inability of prices to convey information about the value attached to quality by inframarginal consumers. In the regulatory context, this market problem appears in the form of a difficult informational question for the regulator; what is the average valuation of quality over all the consumers in the market? The paper suggests that rate-of-return regulation may have attractive features when quality is a variable.