Scandinavian Working Papers in Economics

Discussion Paper Series in Economics,
Norwegian School of Economics, Department of Economics

No 2/2011: Quality competition with profit constraints: Do non-profit firms provide higher quality than for-profit firms?

Kurt R. Brekke (), Luigi Siciliani () and Odd Rune Straume ()
Additional contact information
Kurt R. Brekke: Dept. of Economics, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Economics, Helleveien 30, N-5045 Bergen, Norway
Luigi Siciliani: University of York, Postal: Department of Economics and Centre for Health Economics, , University of York, , Heslington, York YO10 5DD, UK
Odd Rune Straume: University of Minho, Postal: Department of Economics/NIPE, , University of Minho, , Campus de Gualtar, 4710-057, Braga, Portugal

Abstract: In many markets, such as education, health care and public utilities, firms are often profit-constrained either due to regulation or because they have non-profit status. At the same time such firms might have altruistic concerns towards consumers. In this paper we study semi-altruistic firms’ incentives to invest in quality and cost-reducing effort when facing constraints on the distribution of profits. Using a spatial competition framework, we derive the equilibrium outcomes under both quality competition with regulated prices and qualityprice competition. Profit constraints always lead to lower cost-efficiency, whereas the effects on quality and price are ambiguous. If altruism is high (low), profit-constrained firms offer higher (lower) quality and lower (higher) prices than firms that are not profit-constrained. Compared with the first-best outcome, the cost-efficiency of profit-constrained firms is too low, while quality might be over- or underprovided. Profit constraints may improve welfare and be a complement or substitute to a higher regulated price, depending on the degree of altruism.

Keywords: Profit constraints; Quality competition; Semi-altruistic providers.

JEL-codes: D21; D43; L13; L30

40 pages, February 7, 2011

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