Quality competition with motivated providers and sluggish demand

Posted by D. Daniel Sokol

Luigi Siciliani (Department of Economics and Centre for Health Economics, University of York, Heslington), Odd Rune Straume (Universidade do Minho - NIPE), and Roberto Cellini (Department of Economics, University of Catania) explain Quality competition with motivated providers and sluggish demand.

ABSTRACT: We study incentives for quality provision in markets where providers are motivated (semi-altruistic); prices are regulated and firms are funded by a combination of block grants and unit prices; competition is based on quality, and demand adjusts sluggishly. Health or education are sectors in which the mentioned features are the rule. We show that the presence of motivated providers makes dynamic competition tougher, resulting in higher steady-state levels of quality in the closed-loop solutions than in the benchmark open-loop solution, if the price is sufficiently high. However, this result is reversed if the price is sufficiently low (and below unit costs). Sufficiently low prices also imply that a reduction in demand sluggishness will lead to lower steady-state quality. Prices below unit costs will nevertheless be welfare optimal if the providers are sufficiently motivated.