Optimal regulation with unknown demand and cost functions

This paper presents an analysis of optimal regulation of a firm that has private information about both its cost and demand functions. An earlier paper on the same topic, Lewis and Sappington (Rand J. Econ. 19 (1998), 438-457), is reviewed, a difficulty with their analysis is discussed, and an alternative formulation of their model is proposed. Two broad classes of problem are considered: (i) the case where social and private incentives are roughly aligned, which implies optimal prices are (weakly) above marginal costs, and (ii) the case where social and private incentives diverge, which implies pricing below marginal cost may be optimal. Journal of Economic Literature Classification Numbers: D42, D82, L51 (C) 1999 Academic Press.