Universal Service Obligations in LDCS: The Effect of Uniform Pricing On Infrastructure Access

Journal of Public Economics 90 (2006) 1155 – 1179
www.elsevier.com/locate/econbase
Universal service obligations in LDCs: The effect of

uniform pricing on infrastructure access
Antonio Estache a,b,*, Jean-Jacques Laffont c,F, Xinzhu Zhang d
a
World Bank, Washington, D.C. 20433, USA
b
ESCARES, Universite Libre de Bruxelles, Belgium
c
IDEI and Université des Sciences Sociales, Place Anatole, 31042 Toulouse Cedex, France
d
Research Center for Regulation and Competition, Chinese Academy of Social Sciences,
Beijing 100732, P.R. China
Received 9 August 2004; received in revised form 13 July 2005; accepted 14 July 2005
Available online 9 September 2005
Abstract
This paper develops a model to analyze the impacts of asymmetric information on optimal
universal service policy in the public utilities of developing countries. Optimal universal service
policy is implemented using two regulatory instruments: pricing and network investment. Under
discriminatory pricing asymmetric information leads to a higher price and smaller network in the
rural area than under full information. Under uniform pricing the price is also lower but the network
is even smaller. In addition, under both pricing regimes not only the firm but also taxpayers have
incentives to collude with the regulator.
D 2005 Elsevier B.V. All rights reserved.
JEL classification: L43; D82; O12

Keywords: Universal service obligations; Asymmetric information; Collusion
* Corresponding author. World Bank, Washington, D.C. 20433, USA. Tel.: +1 202 458 1442; fax: +1 202 522
2961.
E-mail address: aestache@worldbank.org (A. Estache).
F
Professor Laffont passed away on May 1, 2004.
0047-2727/$ - see front matter D 2005 Elsevier B.V. All rights reserved.
doi:10.1016/j.jpubeco.2005.07.002
1156 A. Estache et al. / Journal of Public Economics 90 (2006) 1155–1179
1. Introduction
Universal service obligations have played a prominent role in policy debates on public
utilities in developed economies.1 In the United States, for instance, a large part of the
1996 Telecommunications Act is devoted to reforming universal service obligations, and
the Federal Communications Commission has made enormous efforts to implement these
obligations. Governments in developing countries have also viewed these obligations as an
important social commitment and implemented universal service policies—to varying
degrees—as part of regulatory reforms (see Clark and Wallsten (2002) for an overview).
For developing countries universal service obligations are broadly viewed by politicians
and policy makers as a necessary component of equitable development strategies-
redistribution toward the poor and the underdeveloped regions as part of USOs.
Still, universal service obligations have created considerable controversies in reform
processes and raised many practical and theoretical issues—two of which are especially
relevant to developing countries.2 The first is how best to promote network expansion.
Unlike in industrial countries, where penetration of basic infrastructure services is no
longer an issue,3 in developing countries many people still lack these services, particularly
in rural areas. Thus network expansion remains an essential dimension of universal service
policies in developing countries.
The other important issue in developing countries is the design of pricing policy
instruments to support universal service obligations. Because the necessary fiscal
instruments are often not available, policy makers have traditionally tended to rely mostly
on simple pricing policies to achieve both allocative efficiency and redistribution goals.
USOs have indeed often been financed by cross-subsidies across clients of the monopoly
responsible for service delivery. But this historical approach needs to be reassessed once
competition is introduced in a sector and regulatory decisions associated with the specific
economic characteristics of the sector and the service users need to be designed. This is a
particularly difficult challenge in developing countries which generally have limited
experience in regulating infrastructure in a competitive environment and where regulatory
capture risks may be associated with institutional limitations.
The paper is indeed very much anchored into a large number of instances in which
the two concerns have been central to public service reform in developing countries. The
recent history of China’s telecoms sector is a good illustration. As many other countries,
China used to finance USOs in the telecoms sector through cross-subsidies when
competition had not been introduced and/or new USO mechanism had not yet been
developed. Long distance calls were priced higher than their costs to finance tariff for
local calls lower than costs. However, in China as in many other developing countries,
the rural users did not benefit from these cross-subsidies. Rural investment costs were
1
For recent overview of the economics of USO, see Cremer et al. (2001). See also Laffont and Tirole (2002) for
an application to the telecommunications sector.
2
There is very little academic literature on universal services obligations in developing countries. For an
overview of the developing countries experience in adopting USO, see Chisari et al. (2003), Clark and Wallsten
(2002), Estache et al. (2003), Laffont and N’Gbo (2000) or Gasmi et al. (1999).
3
People might object that what is bbasicQ get refined. So bInternet accessQ has now become a subject of debate
as many now still don’t have access in developed countries.
A. Estache et al. / Journal of Public Economics 90 (2006) 1155–1179 1157
typically higher than what would be covered by the cross-subsidy. To compensate for
the cost differentials, rural users would actually in general pay higher tariffs than urban
users. This price differential was however generally not enough to provide an incentive
to operators to rebalance their efforts to expand investment and service in rural areas and
hence allow the government to achieve its universal service objectives. In 2001, the
Chinese government abolished this discriminatory pricing between rural and urban users
by adopting a policy of uniform pricing with a local network whether rural or urban.
This change in pricing strategy proved to be worsening the universal service concern of
the regulators. Without the introduction of the new USO mechanisms, the distortions
penalizing rural expansions and favoring urban expansions were exacerbated. The
example illustrates the extent to which the incentives built-in the pricing design can be
instrumental in the implementation of policies aimed at achieving universal access to a
public service. The formalization of the relevance of these incentive issues in the design
of the regulation associated with universal concerns illustrated by the Chinese example
and of the trade-offs associated with the main regulatory options generally considered
are the main purpose of this paper.
Indeed, the main contribution of this paper is to use incentive theory to analyze these
specific policy issues in developing countries. It provides a first step toward
understanding the theoretical foundations of universal service policies from a normative
point of view, and the associated features of political economy in developing countries.
To do so, the paper develops a simple model based on asymmetric information, in which
a developing country government lacks information about a monopolistic firm’s
marginal cost of providing an infrastructure service in a rural area. The model is used
to analyze the impacts of asymmetric information and the threat of regulatory capture on
optimal universal service policy in the public utilities of developing countries. Here
optimal universal service policy is implemented using two regulatory instruments:
pricing and network investment. The analysis is conducted under both discriminatory
pricing (between urban and rural areas) and uniform pricing. The results show that under
both pricing regimes, asymmetric information results in a higher price and smaller
network in the rural area than does complete information. More importantly, although
uniform pricing leads to a lower price in the rural area, the network size is smaller than
under discriminatory pricing.
When considering the possibilities of collusion between various actors, the analysis
here relies on the hard information structure used in Tirole (1986) and Laffont and Tirole
(1993). An important feature of our model is that multiple interest groups have incentives
to collude with the regulator. The firm, which obtains an information rent if the regulator
does not reveal its private information, has incentives to collude with the regulator if it is
relying on a low-cost technology. At the same time, taxpayers may benefit from
information hiding by the regulator (by paying less taxes) if the firm uses a high-cost
technology.4 Although collusion between the regulator and taxpayers may be difficult—
since taxpayers are often not well organized—our analysis points out the stakes that
4
In developed countries and some developing economies, USO cost is usually born by users in other regions or
richer users rather than by taxpayers. So the relevant collusion would be with a roundtable of metropolitan areas
rather than with taxpayers.
taxpayers may have in a specific universal service policy. Preventing collusion between
the regulator and the firm requires increasing the price and reducing the size of the
network for the rural area. But prevention of collusion between the regulator and taxpayers
needs opposite regulatory responses. Therefore, the existence of taxpayers as an interest
group hardens the coalition incentive constraint for the regulator and the firm.
The rest of the paper is organized as follows: Section 2 establishes the basic setting for
the analysis and the resulting model. After that optimal regulation of pricing is considered,
with analysis of discriminatory pricing in Section 3 and uniform pricing in Section 4. We
analyze the impacts of the threat of collusion in Section 5. Section 6 then concludes.
2. The basic setting
Consider a simple principal–agent relationship between a benevolent government and a

monopolistic firm that is regulated when providing, for instance, telecommunications
services in a specific territory. The firm’s territory is divided into two areas: a low-cost
urban one and a high-cost rural one. Let a 1 be the share of the population in the urban area
and a 2 the share in the rural area, with a 1 + a 2 = 1.
Assume that the marginal cost of providing services in the urban area is c 1, which is
common knowledge. One can think of this assumption as a reduced form of competition in
the urban sector. But the government has asymmetric information about c 2, the marginal
cost of providing services in the rural area. For simplicity assume that there are only two
possible cost levels or two types—that is, c2 a {c 2, c̄ 2} and c 2 N c 1, with probability
distribution Pr(c 2 = c 2) = m and Pr(c 2 = c̄ 2) = 1 m. Let Dc 2 u c̄ 2 c 2 N 0.
Assume also that full service coverage has been achieved in the urban area but that
the rural area is only partially connected. Denote l b 1 the proportion of households in
the rural area which are connected. Because some people in the rural area are not
connected, the government imposes universal service obligations on the monopolistic
firm in the form of specified pricing and network expansion in the rural area. Assume
that the cost of network investment C(l) is a convex function satisfying CV(d ) N 0 and
CW(d ) N 0.
Let S( q) be the gross social surplus for subscribers, derived from consumption of the
service in both low-cost and high-cost areas, and P( q) the corresponding inverse
demand function. Assume that |SW| is large enough throughout the paper so that the
optimization programs are concave. To simplify our analysis, we do not consider
consumers’ connection decisions, which means that consumers derive the entire surplus
from consumption of services and all capacities are used immediately, because we focus
on linear pricing which is one way of getting users to enjoy a rent from getting
connected; alternatively, users could be heterogeneous and non-linear pricing could be
used. We also assume for simplicity that consumers have a demand with constant
absolute elasticity g N 1.
The timing of events is as follows. After the firm learns its private information about c 2
the government determines regulatory policies for services prices and network sizes in
both urban and rural areas. The firm then invests to expand the rural network, and
consumers make decisions about consumption.
3. Optimal regulation under price discrimination
This section considers the case where price discrimination is allowed, so that the
regulator sets different prices ( p 1 and p 2) for each area and consumers consume q 1 and q 2
accordingly. In that case the firm’s utility function is:
U ¼ t þ a1 Pðq1 Þq1 þ a2 lPðq2 Þq2 ½a1 c1 qðp1 Þ þ a2 lc2 qðp2 Þ C ðlÞ; ð1Þ
where t is the monetary transfer obtained from the government since we do not constrain
the firm to balance its budget.5
We assume that the benevolent regulator has a utilitarian social welfare function. Then,
W ¼ a1 ½S ðqðp1 ÞÞ p1 qðp1 Þ þ a2 l½S ðqðp2 ÞÞ p2 qðp2 Þ ð1 þ kÞt þ U ; ð2Þ
where k N 0 is the shadow cost of public funds, which is exogenous. Substituting from (1)
the transfer t, we can rewrite the objective function as:
W ¼ a1 ½S ðqðp1 ÞÞ þ kp1 qðp1 Þ þ a2 l½S ðqðp2 ÞÞ þ kp2 qðp2 Þ
ð1 þ kÞ½a1 c1 qðp1 Þ þ a2 lc2 qðp2 Þ þ C ðlÞ kU : ð3Þ
For expositional simplicity the following notation is introduced:
p i ; q̄
p̄ qi and p i ; q i
P P
are the price and quantity when c 2 is c̄ 2 and c̄ 2, respectively; and similarly
t¯ ¼ t ðc̄c 2 Þ P
t ¼ tðP
c 2 Þ l̄
l ¼ lðc̄c 2 Þ l ¼ lðP c 2 Þ:
P
Before proceeding further, we derive the benchmark result under full information. The
following participation constraints have to be satisfied to induce voluntary participation for
the high-cost (or bad-type) firm:
t¯ þ a1 p̄ q 1 þ a2 lp
p 1 q̄ P
q 2 ða1 c1 q̄
2 q̄ q 1 þ a2 lc
P
q 2 Þ C ðl̄
2 q̄ l Þz0; ð4Þ
and for the low-cost (or good-type) firm:
t þ a1 p 1 q 1 þ a2 lp 2 q 2 ða1 c1 q 1 þ a2 lc 2 q 2 Þ Cðl Þz0:
P
ð5Þ
P P P P P P P P
So, the government’s optimal regulatory policy under complete information can be
obtained by solving the following program:
max ma ðSðq Þ þ k p q Þ þ a l ðSð q Þ þ k p q Þ
q ;q̄q ;l̄
q ;q ;l ;U ;q̄ l;U
P 1 1 1 1 2 2 2 2
P1 P 2 P P 1 2 P P P P P P P

ð1 þ kÞða1 c1 q 1 þ a2 l P
c 2 q 2 þ Cð l ÞÞ k U
P
P P P P
þ ð1 mÞfa1 ðS ðq̄
q 1 þ kp̄ q 1 Þ þ a2 l̄
p 1 q̄ l ðS ðq̄
q 2 Þ þ kp̄p 2 q̄q 2 Þ ð1 þ kÞ

ða c q̄
q þ a lc q̄
1 1 1
P q þ C ðl̄
2 l ÞÞ kŪ
2 2 U
s.t. (4) and (5).
5
Alternatively, the firm could have fixed costs and face a budget constraint. Then nothing changes except: (1)
that k is the shadow cost of the budget constraint; (2) collusion is then with users in the urban area rather than
with taxpayers, and (3) things will definitely be more complicated.
Optimal regulation then entails:

Proposition 1. Under complete information and discriminatory pricing the optimal prices
follow the Ramsey rule and the optimal size of the network is such that the social marginal
cost of network expansion is equal to the social marginal gain. More precisely,
p * c1
P1 pp̄* c1 k 1
¼ 1 ¼
*
p1 *
p̄ 1
p 1þk g
P
p * c2
P2 pp̄* c̄c 2 k 1
¼ 2 ¼
*
p2 p̄
p *
2 1 þ k g
P

* * *
ð1 þ kÞC V l * ¼ a2 S q 2 þ k p2 q 2 ð1 þ kÞ P *
c 2 q2
P P P P P
ð1 þ kÞC Vðl̄ q*2 Þ þ kp̄

l*Þ ¼ a2 ½S ðq̄ p*2 q̄
q*2 ð1 þ kÞc̄c 2 q̄q*2 :
Proof. See the Appendix. 5

Under complete information the regulator needs only to satisfy the participation
constraints of the monopolistic firm so that no information rent is left to the firm. The
optimal prices are set according to Ramsey principles. Mark-ups above marginal costs are
due to the social cost of public funds.
To determine the optimal size of the network, one needs to take into account two types
of benefits from providing services in the rural area. The net surplus effect,
S(q̄ 2) (1 + k)c̄ 2q̄ 2, represents the net benefits from consumption obtained by those
connected to the rural network. The revenue effect, kp̄ 2q̄ 2, is the social gain of revenues
from those same consumers. Simple inspection of the first-order conditions shows that
p̄ 1* = p̄ 1* = p 1* and p 2* b p̄ 2*. Moreover, l* N l̄*. In other words, a higher marginal cost leads
–
to a higher price and smaller network for the rural area.
By differentiating the network investment equation with respect to k, one can find that
the network size is a decreasing function of the social cost of public funds—that is, dlT dk b 0
if CVis large enough (see the Appendix). So in a typical developing country, where k is
larger than in industrial economies, network should be smaller from a normative point of
view.
Now assume that the regulator has asymmetric information about c 2. Using the
revelation principle, we can without loss of generality restrict our attention to regulatory
rules that are direct revelation mechanisms. Here a direct revelation mechanism is
characterized by:
fp1 ðc̃c 2 Þ; p2 ðc̃c 2 Þ; lðc̃c 2 Þ; t ðc̃c 2 Þg with c̃c 2 afP

c 2 ; c̄c 2 g
where c̃ 2 is the monopolist’s report to the government about its c 2.

For incentive compatibility, the following incentive constraints must be satisfied for the
high-cost (bad-type) firm:
t¯ þ a1 p̄ q 1 þ a2 l
p 1 q̄ 2 q 2 ða1 c1 q̄
Pp q̄ q 1 þ a2 l 2 q 2 Þ C ðl̄
Pc q̄ l Þz P
t þ a1 p 1 q 1
P P

þ a2 lp 2 q 2 a1 c1 q 1 þ a2 l c̄c 2 q 2 C l ð6Þ
PP P P P P P
and for the low-cost (good-type) firm:

P
t þ a1 p 1 q 1 þ a2 l p 2 q 2 a1 c 1 q 1 þ a2 l Pc 2 q 2 Þ C l zt¯ þ a1 p̄p 1 q̄q 1
P P PP P P P P P

þ a2 l 2 q 2 a1 c1 q̄
Pp q̄ c 2 lPq 2 C ðl̄
q 1 þ a2 P l Þ:
Thus the government’s program is:

max m a1 ðSðq
P
1 Þ þ k p 1 q 1 Þ þ a2 l ðSð q 2 Þ þ k p 2 q 2 Þ
P P P P P P
q1 ;q2 ;l ;U q 1 ;q̄q 2 ;l̄
;q̄ l;Ū
U
P P P P

ð 1 þ kÞ a1 c 1 q 1 þ a 2 l P
c 2 q 2 þ C l kU
P
P P P P
þ ð1 mÞfa1 ðS ðq̄
q 1 Þ þ kp̄ q 1 Þ þ a2 l̄
p 1 q̄ l ðS ðq̄q 2 Þ þ kp̄p 2 q̄q 2 Þ ð1 þ kÞ

ða c q̄
q þ a lc q̄
1 1 1
P q þ C ðl̄
2 l ÞÞ kŪ
U
2 2
s.t. (4), (5), (6), and (7).

That leads to the following result:
Proposition 2. Under asymmetric information and discriminatory pricing the optimal
regulatory policy entails:
(1) If c 2 = c 2 , the optimal price and network size for the rural area are the same
as under complete information;
(2) If c 2 = c̄ 2 , asymmetric information leads to a higher price and smaller network
for the rural area than under complete information.
More specifically,
p SB p SB
1 ¼ p̄ * SB * SB ¼ l *
1 ¼ p1 ; p 2 ¼ p 2 ; l
P P P P P
p̄ SB
p 2 c̄ c2 k 1 k m Dc2
SB
¼ þ
p2
p̄ p SB
1 þ k g 1 þ k 1 m p̄ 2
SB h m i
ð1 þ kÞCV l̄
l q SB
¼ a2 S q̄ 2 p SB
þ kp̄ q SB
2 q̄ c 2 q̄q SB
2 ð1 þ kÞc̄ 2 k Dc2 q̄q SB
2 :
1m

Under asymmetric information the regulator has to give up an information rent

P = a 2l̄Dc 2q̄ 2 to the efficient firm to satisfy incentive compatibility. Both the optimal price
and the optimal network size for the rural area when c 2 = c̄ 2 are distorted to mitigate this
rent. Indeed, the optimal price in the rural area p̄ 2 is increased (consumption q̄ 2 decreased)
¯
and the optimal network size l 2 decreased relative to the first-best allocations. Therefore,
there are two effects distorting the optimal network size away from the first-best level if
m N 0: (1) q̄ 2 is reduced, which leads to a reduction in l̄2; and (2) l̄ 2 itself is reduced to
lower the rent (see the Appendix).
Proposition 2 says that when price discrimination is allowed, under asymmetric
information rural consumers face a higher price due to the information cost and so
consume a lower level of services. Moreover, people without connections are less likely to
be connected because the information rent increases the investment cost. Thus asymmetric
information adversely affects both the connected and unconnected consumers in the rural
area.
4. Optimal regulation under uniform pricing
This section derives the optimal regulatory policy under uniform pricing. As before, we
first consider the benchmark case in which there is complete information about the cost of
providing services in the rural area, c 2. For expositional simplicity, more notation is
introduced: p̄ = p(c̄ 2), q̄ = q(p̄), p = p(c̄ 2), and q = q(p). Other notational conventions are
defined as in the previous section.
Under complete information the following participation constraints must be satisfied for
the high-cost (bad-type) firm:
t¯ þ ða1 þ a2 l̄ Pq ða c þ a c̄c l̄
l Þp 1 1 2 2 l Þq̄
q C ðl̄
l Þz0; ð8Þ

t þ a1 þ a2 l p q a1 c 1 þ a2 P
P
c 2 l q C l z0: ð9Þ
P PP P P P
The government optimizes the following objective function:

max W ¼ m a1 þ a2 l S q þ k p q ð 1 kÞ
P P PP
p;l̄
p ;l ;p̄ l

PP
c 2 q þ C l kU
a1 c 1 þ a2 l P P
þ ð1 mÞfða1 þ a2 l̄
lÞ
P P P
ðS ðq̄ Pq Þ ð1 kÞ½ða1 c1 þ a2 lPc 2 Þq̄q þ C ðl̄

q Þ þ kp l Þ kŪ
Ug
subject to constraints (8) and (9).

Then optimal regulation entails:

Proposition 3. Suppose that the government has complete information about c 2 . Then
uniform pricing reduces both the price and the network size for the rural area relative to
those under price discrimination. 6 More specifically,
a 1 c 1 þ a2 P lTT
c 2P l TT
a1 c1 þ a2 c̄c 2 l̄
pTT p̄ TT
p
P a1 þ lTT
a2 P l TT
a1 þ a2 l̄ k 1
¼ TT
¼
pTT
P
p
p̄ 1þk g

ð1 þ kÞCV l ** ¼ a2 S q ** þ k p ** q ** ð1 þ kÞ P
c 2 q **
P P P P P
TT
TT
ð1 þ kÞCV l̄
l ¼ a2 S q̄ p TT q̄
q þ kp̄ q TT ð1 þ kÞc̄c 2 q̄q TT :

Under complete information the optimal allocation under uniform pricing can be
implemented without giving up any information rent. Again, the prices are determined by
the Ramsey rule. When the marginal cost in the rural area is c 2 (resp. c̄ 2) the relevant cost
a1 c1 þa2 c 2 l
is the average marginal cost a1 þa2Pl P (resp. a1ac11þa c 2 l̄
2 c̄
þa2 l̄
l
l ), which is lower than c 2 (resp. c̄ 2)
but higher than the marginal cost in the urban area, c 1. Thus uniform pricing leads to the
P
redistributive outcome of a lower price for the rural area and a higher price for the urban
area regardless of the network size—that is, p*1 b p** b p*2 and p*1 b p** b p*2 . But as we will
see soon, pricing favoritism towards the rural area is achieved with a distortion—resulting
in a smaller network.
When the monopolistic firm is endowed with a high-cost technology (that is c 2 = c 2),
CV(l̄) is the marginal cost of network expansion in the rural area. As before, two benefits of
network expansion must be taken into account. One is the net surplus effect from
consumption, S(q̄) (1 + k)q—c2; the other is the revenue effect resulting from the social
cost of public funds. But unlike under price discrimination, the net effect entails that
S(q̄) + kp—q (1 + k)q—c2 is a decreasing function of q̄ at q̄** rather than a constant function.
The reason is that uniform pricing creates a distortion resulting in a lower price in¯ the rural
area, which causes a distortion toward the size of the network. Thus l ** b l * and l ** b l̄*.
– –
A few remarks about uniform pricing are in order. Universal service obligations are
often implemented using uniform pricing (such as for postal or telephone services).
Although this regulatory policy may have political advantages, it is not necessarily the
right approach to favor the rural area. For instance, the government could take a different
approach to the design of its redistributive policy by changing the weights of consumers in
different areas in the objective function. To illustrate this point, assume that the
government puts a weight x N 1 on the net consumer surplus in the rural area, which
6
CW and a 1 area sufficient conditions to ensure that we will focus on the interest case where the price is higher
and the network smaller for c̄ 2 than c 1.
implies that it places a higher value on the surplus of these consumers. By simple
manipulation the government’s objective function can be written as:
W ¼ a1 ðS ðq1 Þ p1 q1 Þ þ a2 lxðS ðq2 Þ p2 q2 Þ ð1 þ kÞt þ U

1þk
¼ a1 ðS ðq1 Þ þ kp1 q1 Þ þ a2 lx S ðq2 Þ þ 1 p2 q2
x
ð1 þ kÞða1 c1 q1 þ a2 c2 lq2 þ C ðlÞÞ:
We thus obtain:

px
2 c2 x 1
x ¼ 1
p2 1þk g

1þk
ð x Þ ¼ a2 x S qx
ð1 þ kÞCVl 2 þ 1 p x x
q
2 2 ð 1 þ k Þc q x
2 2 :
x
We now compare the network sizes under favoritism toward the rural area in the
objective function and uniform pricing, respectively. For this comparison, assume that the
x
price for the rural area is the same under different h regimes.i We substitute p 2 = p̄** into the
TT
above pricing
function to get x = (1 + k) 1 p̄p p̄pc̄ TT
c2
g . One can show that x(S(q̄**)+
1þk
x 1 p̄**q̄** (1 + k)c̄ 2 q̄** N S(q̄**) + kp̄**q̄** (1 + k)c̄ 2q̄**.7 In other words, uni-
form pricing induces a smaller network with the same price for rural areas and achieves a
lower level of social welfare with a weight, that induces the same price in rural areas. We
can therefore conclude that, under complete information, favoring rural areas with proper
price discrimination is a better way of implementing redistribution than using uniform
pricing, if it is politically feasible.8
Assume now that the social planner has asymmetric information about c 2 The
regulatory policy under uniform pricing (with x = 1) can be defined as the following direct
revelation mechanism:

f pðc̃c 2 Þ; l̃
l; ðc̃c 2 Þ; t ðc̃c 2 Þg with c̃c 2 in Pc 2 ; c̄c 2 :
Then the following incentive constraints need to be satisfied for the high-cost (bad-
type) firm:

t¯ þ ða1 þ a2 l̄ Pq ða1 c1 þ a2 c̄c 2 l̄
l Þp l Þq̄ l Þz t þ a1 þ a2 l pq
q C ðl̄ P P PP

a1 c1 þ a2 l c̄c 2 q C l ð10Þ
P P P

t þ a1 þ a2 l p q a1 c1 þ a2 l c̄c 2 q C l zt¯ þ ða1 þ a2 l̄
P
l Þp
Pq
P PP P P P

a1 c1 þ a2 l̄
lc q C ðl̄
P 2 q̄ l Þ: ð11Þ

TT
p̄p TT c̄c 2
TT
7
Since p̄p p̄pc̄
TT
c2 k 1
1þk k 1
g b0; by collecting terms one has 1þk g p̄p TT S q̄q p̄p TT q̄q TT N0:
8
However, since our focus is on pricing as a way of redistribution, we remain the assumption of x = 1
throughout the paper.
The government needs to solve the following program for the optimal regulatory policy:

max m a1 þ a2 P l S q þ k p q ð 1 þ kÞ a1 c 1 þ a2 P
P PP
c2l q
P P
q;l̄
q ;l ;U ;q̄ l;Ū
U
P P P

þ C l kU P
þ ð1 mÞfða1 þ a2 l̄ l ÞðS ðq̄q Þ þ k P
pq Þ
P

ð1 þ kÞ½ða1 c1 þ a2 c̄c 2 l̄
l Þq̄
q þ C ðl̄
l Þ kŪ
U
s.t. (8), (9), (10), and (11).
We can now state the next result:
Proposition 4. Suppose that the government has asymmetric information about c 2 and
uses uniform pricing. Then:
(1) When the size of information asymmetry Dc 2 is large enough:
i) If c 2 = c 2 , the optimal regulatory rule is the same as under complete information

with uniform pricing; and
ii) If c 2 = c̄ 2 , the price is higher and the network size smaller in the rural area than
under complete information with uniform pricing. Moreover, the price is lower and
the network smaller than under asymmetric information with discriminatory pricing.
More specifically,
p 1USB ¼ p**
1 ;l
USB
¼ l **
P P P
l USB
a1 c1 þ a2 c̄c 2 l̄
p̄ USB
p
l USB
a1 þ a2 l̄ k 1 k m l USB
a2 Dc2 l̄ 1
USB
¼ þ USB USB
p
p̄ 1 þ k g 1 þ k 1 m a1 þ a2 l̄
l pp̄
USB h m i
ð1 þ kÞCV l̄
l q USB þ kp̄
¼ a2 S q̄ p USB q̄
q USB ð1 þ kÞc̄c 2 q̄q USB k Dc2 q̄q USB ;
1m
(2) When the size of information asymmetry Dc 2 is small enough, bunching occurs and
optimal regulation entails:

USB
c 2 þ ð1 mÞc̄c 2 lUSB
a1 c 1 þ a2 m P
p
a1 þ a2 lUSB k 1 k ma2 Dc2 lUSB 1
¼ þ
pUSB 1 þ k g 1 þ k a1 þ a2 lUSB pUSB
USB
USB S q USB USB
þkp q k
CVl ¼a2 mPc 2 þð1 mÞc̄c 2 qUSB mDc2 qUSB :
1þk 1þk

Under uniform pricing and asymmetric information, the optimal regulatory rule is
obtained when c 2 = c̄ 2—that is, there is no distortion at top. But since the government has
to give up an information rent, a 2l̄Dc 2q̄, to the firm in order to induce truthful revelation
of its information, both the price and the network size are distorted as a result of the
efficiency-rent-extraction trade-off when the firm has a high-cost technology.
Uniform pricing under asymmetric information has two effects on the pricing decision.
One is the direct effect of asymmetric information, which leads to a higher price. The other
is the average marginal cost effect caused by uniform pricing, which tends to induce a
lower price. The net effect is in general
¯ ambiguous because the first-order conditions are
simultaneous equations of p̄ and l . But if the size of information asymmetry Dc 2 is large
enough, under uniform pricing the price for the rural area is higher than under complete
information.
To determine the optimal network investment, one needs now to take into account three
effects: In addition to the surplus effect and the revenue effect, there is a direct effect of
asymmetric information that calls for a reduction of the network size. The net effect is to
induce a smaller network if Dc 2 is large enough.
Next we compare these results with those under discriminatory pricing. There are two
effects that need to be considered. In addition to the average marginal cost effect, which
leads to a decrease in price, there is another effect which, by reducing information cost,
also induces a lower price. Therefore, the price under uniform pricing P
is always lower than
under discriminatory pricing. More specifically, denote p̄pu a1 pa11þa 2lp2
þa2 l̄
l as the average price
under price discrimination, one can obtain that the price under uniform pricing is equal to
the average price under discrimination p̄ p USB for a given size of the network. As a
p ¼ p̄
result the size of the network under uniform pricing is smaller than under discriminatory
pricing. We thus conclude that, while under asymmetric information, uniform pricing does
favor the rural people contrary to what was observed under full information, it does so at
the expense of network expansion, therefore penalizing unconnected users (as well as
future users).
An interesting additional result under uniform pricing is that bunching occurs if Dc 2
is small enough. In that case optimization of the social welfare calls for consumption
and network investment to be decreasing functions of c 2.9 But in the presence of
asymmetric information, if Dc 2 is small enough, the second-order condition of truth-telling
requires both the consumption and the network size be increasing functions of c 2.10 These
opposite monotonic conditions required by the optimization of the objective function and
the implementability of allocations or by satisfying incentive compatibility lead to the non-
responsiveness result. That is, screening is no longer possible with uniform pricing.11
5. Universal service policy under collusion
We now consider the possibility of collusion, to illustrate in a very simple setting

the impact of collusion on the optimal regulatory policy. For this purpose we add to
9
Note that in the optimal allocation under complete information, monotonicity is satisfied if a 1 is large enough.
10
Here the action space is two dimensional.
11
For an exposition of this non-responsiveness result in a model with a single action see Laffont and Martimort
(2002, p. 53).
the basic principal–agent relationship between the government and the monopolist firm
a hierarchical level representing the regulator of the firm. We also consider other
interest groups which have stakes in regulation. Indeed, a special feature of this paper
is that in addition to the threat of collusion between the regulator and the firm,
collusion may arise between the regulator and other interest groups such as taxpayers
and rural consumers.
Following Tirole (1986), we assume that the regulator’s role is to bridge the
government’s information gap about c 2. Suppose the regulator has utility function:
RðsÞ ¼ s and sz0; ð12Þ
where s is the regulator’s reward. The regulator is risk neutral but is protected by
limited liability. Therefore, to obtain the regulator’s participation he should get at least
his reservation utility level, which is normalized to be zero.
Assume that the regulator is endowed with an information technology that he uses
to obtain a private signal (r = c 2) about the monopolist’s cost in the rural area with
probability n and learns nothing (r = /) with probability 1 n. For simplicity we
assume that the regulator’s information is known to the monopolistic firm and other
possible interest groups. In other words, side-contracting is assumed to take place
under complete information.12 To make use of the regulator’s information r, the
government asks him to report the signal he has received—that is, r a {c 2, c̄ 2, /}. The
critical assumption is that the signal the regulator reports to the government is hard
information—when a signal is reported to the government, it is hard evidence. But the
regulator can hide information and report that the signal is /. If the regulator learns
nothing, he must report r = /. Thus the regulator has discretion only when he receives a
signal that reveals the firm’s private information. The regulator’s information technology
is summarized in the following table describing the probability of each state of nature.
c2
Type P c2
Type P
P
r¼ c2 mn 0
r =/ m(1 n) (1 m)(1 n)
r¼P c2 0 (1 m)n
The timing of the regulatory game in the presence of a collusion threat between the
regulator and the monopolist and other interest groups is as follows. The government
offers a grand contract after the regulator, the firm, and other interest groups learn their
respective information.13 The regulator then makes a take-it-or-leave-it offer to the firm
12
One can think of the principal as the public opinion and the regulator is an independent regulator. Thus it is
possible that many people such as the firm, urban and rural users, and taxpayers are informed but the government
is not.
13
One may be worried about the possibility of Maskin games (Maskin, 1999)—that is, pushing one group against
another to verify information. Indeed, there might exist a more general class of mechanisms (perhaps bizarre) such
as asking urban users to predict what information to regulate. However, as is standard in the literature, we will be
restricting attention to mechanisms in which r is announced by the regulator and c 2 by the firm.
and other interest groups and they decide whether to accept this side-contract. The
government then asks the regulator for a report about the monopolist’s cost. When
evidence is reported by the regulator, the regulatory contract is chosen under complete
information. But when the regulator reports that he has learned nothing, the revelation
game under asymmetric information is played as in the previous section. Finally, the firm
decides whether to accept the grand contract, and both the grand contract and the side
contract will be executed if they are accepted.14
To simplify exposition, the following notation is introduced: q̄ 2c = q(c 2 = c̄ 2, r = c̄ 2),
q 2 = q(c 2 = c̄ 2, r = c̄ 2) q 2c/ = q(c 2=c 2, r = /), and q̄ 2c/ = q(c 2 = c̄ 2, r = /). Other notation such
c
as l c , l c/ , l̄ c , and l̄c/ is similarly defined.

– –
To analyze when collusion matters, assume that the second-best contract under
discriminatory pricing is still offered under the threat of collusion. Let us look first at what
happens if the state of nature is c 2 = c 2 and r = c 2. In this case the firm gets an information
rent of a 2l̄ SBDc 2q̄ 2SB if the regulator hides the information that the firm is efficient. So
there is scope for collusion—the good-type firm may bribe the regulator for his silence.
Thus the government has to satisfy the following coalition incentive constraint to induce
the regulator to tell the truth:

q c/
l c/ q̄
s f [k1 a2 Dc2 l̄ 2 ; ð13Þ
where s f is the reward of the regulator if he reveals that the firm is type c 2, and
1
k1 ¼ 1þk 1
where k 1 represents the transaction cost between the regulator and the firm. To
focus on the interesting case we assume k 1 N k.15 Extending Proposition 2 to take into
account the cost of collusion-proofness, we know that for c 2 = c 2 the price and the
network size are not distorted regardless of the regulator’s report. Thus consumers in
the rural area are not affected by the presence of collusion in this state of nature.
Similarly, urban consumers will not collude with the regulator because of complete
information about c 1. Another potential interest group is taxpayers, who are obliged to
fund any deficit due to the lack of budget constraint for the firm. Nevertheless, because
neither the price nor the network size are distorted by the presence of asymmetric
information, taxpayers will pay the same amount of taxes under asymmetric information
as under complete information. So, taxpayers do not want to collude with the regulator
either. Thus c f N 0 is the only incentive payment to the regulator to induce his truthful
report.
Suppose the state of nature is c 2 = c̄ 2 and r = c̄ 2. In this case the firm does not obtain any
information rent even if the regulator hides the evidence. So, the monopolistic firm does
not want to collude with the regulator. Similarly, urban consumers do not collude with the
regulator. Moreover, we know from Proposition 2 that rural consumers would get a surplus
of a 2l̄*SB(S(q̄ 2SB) p̄ 2SBq̄ 2SB) if the signal were concealed by the regulator, and
a 2l̄*(S(q̄ 2*) p̄*2 q̄*2 ) if the signal were truthfully revealed. Since asymmetric information
14
Note that under our assumption about the regulator’s information technology, the posterior beliefs after an
mð1nÞ
inclusive signal (t) are identical to the prior beliefs: m̂m ¼ mð1nÞþ ð1mÞð1nÞ ¼ m:
15
Otherwise, side-contracting incurs a lower transaction cost than the social cost of public funds and it is optimal
to let collusion take place. So avoiding collusion is not an issue.
leads to a higher price and smaller network for the rural area under price discrimination
and S( q) pq is an increasing function of q in the relevant region, rural consumers would
obtain less surplus from collusion and so do not have any incentive to collude with the
regulator.
For taxpayers, however, if r = c̄ 2 is reported to the government, they will pay:
T c ¼ a1 q̄ p*1 Þ þ a2 l̄
q*1 ðc1 p̄ l* q̄ p*2 Þ þ C ðl̄
q*2 ðc̄c 2 p̄ l* Þ
and
SB
T c/ ¼ a1 q̄
q SB p SB
1 c1 p̄ 1 l SB q̄
þ a2 l̄ q SB
2 c̄c 2 p̄p SB
2 þ C l̄
l
if r is hidden. Since asymmetric information induces a higher price and smaller network in
the rural area, one can check that Tc/ b Tc. In other words, taxpayers pay less to fund the
deficit if the regulator hides the information that r = c̄ 2. Thus taxpayers want to collude
with the regulator if they can overcome the organizational costs involved and ask the
regulator to hide the signal r = c̄ 2 in order to save a tax payment of Tc T /. In this case the
government has to satisfy the following coalition incentive constraint:

ss̄ t [k2 T c T c/ ; ð14Þ
1
where k2 ¼ 1þk 2
and k 2 denotes the transaction cost of side-contracting between the
regulator and taxpayers. Again, we assume k 2 N k to focus on the interesting case
where collusion is an issue. Assume also that the government’s program remains
concave.
Let W FI( q 1c , q 2c , l c ) and W FI( q 1c/ , q 2c/ , l c/ ) denote the expected welfare under full
information and under asymmetric information, respectively. The government optimizes
the following program to solve for the optimal regulatory policy under the threat of
collusion:
n
FI c c c FI c/ c/ c/
n Max o nW q ;
1 2q ; l þ ð 1 n ÞW q 1 ; q 2 ; l
q c;q c;q c/;lc;lc/;q̄q c1 ;q̄q c2 ;q̄q c/
2
l c ;l̄
;l̄ l c/
P1 P2 P2 P P
c o
nmkk1 a2 Dc2 l̄ q c/
l c/ q̄ 2 n ð 1 m Þkk 2 T T c/
subject to constraints (7–10),(13), and (14).

Note that when the state of nature is c 2 = c 2 and r = c 2, the government does not need to
give up any information rent but has to offer an incentive payment, k 1a 2Dc 2l̄c/ q̄ 2c/ , to the
regulator in order to induce truthful revelation of information. In that case regulation is
made under complete information. When the state of nature is c 2 = c̄2 and r = /, regulatory
policies are made under asymmetric information. In this case the government not only has
to pay the regulator’s reservation utility level but has to give up an information rent,
a 2Dc 2l¯c/ q 2c/ to the good-type firm.
When the state of nature is c 2 = c̄ 2 and r = c̄ 2, the monopolistic firm does not
c get any
information rent. But the regulator receives an incentive payment of s̄s t ¼ 1þk1
2
T T c/
to reveal his information.
We thus obtain the following result:

Proposition 5. Under similar assumptions as Proposition 216 and under price
discrimination, the optimal regulatory responses to the threat of collusion call for:
i) When c 2 = c 2 the price and the network size in the rural area are the same as first-
best allocations;
ii) When the state of nature is c 2 = c̄ 2 and r = /, The regulatory response is to reduce
not only the information rent available to the firm but also the tax savings to
taxpayers. The optimal size of the rural network is smaller than without the threat of
collusion. Moreover, the optimal price for the rural area is higher than in the
k k 1
absence of collusion if k1 N 1þk 1 1g k2 = 1 1þk g :
iii) When the state of nature is c 2 = c̄ 2 and r = c̄ 2 , The regulatory response is to reduce
the tax savings available to taxpayers. The optimal price for the rural area is higher
and the optimal size of the rural network is smaller than in the absence of collusion.
More specifically, the optimal regulatory policy entails:

pc ¼ pc/
2 ¼ p*;
c
2 l ¼ l
c/
¼ l*
P2 P P P P P

p̄ c/
p 2 c̄
c2 k n k 1 1
1þ k2 ¼ ½nk2 þ ð1 nÞ
p̄ c/
p 2
1þk 1n 1þk 1n g
k m 1 Dc2
þ ½nk1 þ ð1 nÞ
1 þ k 1 m 1 n p̄p c/
2

p̄ c2 c̄c 2
p k k 1
1þ k2 ¼ ð 1 þ k2 Þ
p c2
p̄ 1þk 1þk g

c/ n
CV l̄l ð1 þ kÞ k k2
1n
"
m qq̄ c/
2 Dc2
¼ a2 S q̄ q c/
2 p c/
þ kp̄ q c/
2 q̄ 2 ð1 þ kÞc̄ q c/
c 2 q̄ 2 k ðk1 n þ ð1 nÞÞ
1m 1n
n
k q c/
k2 q̄ 2 p c/
p̄ 2 c̄
c2
1n

c
ð c¯Þ½ð1 þ kÞ þ kk2 ¼ a2 S q̄
CVl p c2 q̄
q 2 þ kp̄ q c2 ð1 þ kÞc̄c 2 q̄q c2 þ kk2 q̄q c2 p̄p c2 c̄c 2 :
Proof. The proof of Proposition 5 is straightforward so it is omitted. 5

Under our assumptions the binding constraints are the participation constraint of the
bad-type, the incentive constraint of the good-type, and the collusion-proof constraints
(13) and (14). When the state of nature is c 2 = c̄ 2 and r = c̄ 2, since the good-type firm
16
For simplicity we also assume that the second-order condition for the truth-telling is satisfied. Otherwise,
bunching occurs and collusion leads to less screening.
obtains an information rent of a 2Dc 2l̄c/ q̄ 2c/ if the regulator reports r = /, the optimal
regulatory response to the threat of collusion between the firm and the regulator is to raise
the price p̄ 2c/ and reduce the network size l̄ c/ . In other words, incentives given to the firm
are weakened to reduce the stake of collusion.
But when the state of nature is c 2 = c̄ 2 and r = c̄ 2 taxpayers receives a tax saving of
Tc Tc/ if the regulator conceals his information. In this case prevention of collusion
requires lowering the price p̄ 2c/ and raising the network size l̄ c/ on the one hand, and
raising the price p̄ 2c and reducing the network size l̄ c on the other, to reduce taxpayers’
incentives in regulation. Since both incentive payments to the regulator, s f and s̄ t , depend
on the output q̄ 2c/ , we have an interesting case where, from the government’s point of
view, the monopolistic firm and taxpayers have similar incentives to collude with the
regulator—both have stakes in inefficient regulation. As a result the existence of one
coalition incentive constraint hardens the other one, even though these coalition
constraints are associated with different states of nature. Indeed, satisfying the coalition
incentive constraint between the regulator and taxpayers requires that the incentive for
taxpayers are weakened (l̄c/ and q̄ 2c/ are increased); but raising l̄ c/ and q̄ 2c/ strengthens
the incentives offered to the firm which are socially costly. However, it turns out that the
need to reduce the stake of collusion between the regulator and the firm dominates that
between the regulator and taxpayers if k 1 is large or k 1 small. The intuition is simple—if
the transaction cost between the regulator and the firm is small, the collusion threat is then
more likely to be an issue than that between the regulator and taxpayers. Consequently, the
price in the rural area will be higher than without collusion. Conversely, the presence of
collusion induces a lower price for the rural area if k 1 is small.17
At this stage one may wonder whether the result about collusion under discriminatory
pricing also holds under uniform pricing. We show this robustness result in the Appendix
and limit ourselves only with collecting the result below.
Proposition 6. Under the same assumptions as Proposition 4, suppose that uniform
pricing is required and there is a threat of collusion. Then,
(1) When c 2 = c 2 the allocations are the same as under complete information;
(2) When the state of nature is c 2 = c̄ 2 and r = /:
i) The price for the rural area is lower and the size of network is smaller
than under discriminatory pricing, and
ii) If k 1 is large, the price for the rural area is higher and the network size
smaller than in the absence of collusion;
(2) When c 2 = c̄ 2 and r = c̄ 2 , the price is higher and the network size smaller in
the rural area than in the absence of collusion.

17
It is interesting to note that this result is similar to Laffont and Tirole (1993, p. 490) where the existence of a
different interest group (environmentalists) increases the firm’s rent. In both cases the firm and taxpayers have a
stake in making regulation inefficient.
As for the case of discriminatory pricing, the monopolistic firm’s incentives are
weakened by the existence of taxpayers as an interest group. Moreover, allocations are
distorted when c 2 = c̄ 2 and the regulator learns this information and then reports it to the
government. But in both states of nature c 2 = c̄ 2 and r = / and c 2 = c̄ 2 and r = c̄ 2, the price
for the rural area is lower and the size of the network is smaller than those under
discriminatory pricing.
6. Conclusion
The paper presents a formal model to analyze the optimal regulatory policy
associated with the desire to achieve universal service access to public services in
developing countries in situations characterized by information asymmetries. The
model is particularly interesting in showing the perverse incentives associated with
the preference of many politicians to rely on uniform pricing across residential user
types.
The results presented show that the introduction of information asymmetry generates
three important new policy insights. First, they show that efficiency and rent extraction
trade-offs should be a real concern to policymakers in their assessment of pricing options
built in the design of USO policies because of the high cost of public funds in developing
countries. Second, information asymmetry can lead to lack of response of operators to
policy stimulus when both pricing and investment have to be addressed in the optimal
USO policy. This is very different from the fact that under full information there is
always a separating equilibrium. Finally, asymmetric information creates the threat of
collusion, adding a layer to the concerns reformers should account for in reforming USO
policies.
Ultimately, one of the main general conclusions of the paper may be that
uniform pricing may not be the ideal regulatory instrument for governments
concerned with the achievement of universal service concerns. Uniform pricing, even
if it may favor connected rural users, tends to penalize unconnected rural users.
Indeed, it certainly leads to less network expansion than discriminatory pricing.
Pricing and network expansion connections can thus not be addressed as separate
concerns by regulators. Overall, the model presented is thus useful in showing who
wins and who loses under various regulatory design options considered to achieve
universal service,
The second main contribution of the paper relevant to policymakers may be to show
that any reforming government should be concerned with the risks of collusion in the
selection and the implementation of universal service policies. Indeed, the design of this
policy may be relatively easily captured by some of the stakeholders. This is a major
issue in developing countries because network expansion efforts are lowered by the
existence of collusion risks. The reformers should be concerned with multiples sources
of collusion. In particular, the collusion between the operators and the regulator, between
some of the users or between the regulator or between taxpayers and the regulator
should be a serious concern for reforming governments. In general, the optimal
regulatory response to this collusion risk should start with an effort to reduce
information asymmetries by adopting, for instance, regulatory accounting guidelines,

imposing the transparency of the main costs components of the business or relying on
regulatory models designed to assess costs allowed to operators. Overall, however,
designing collusion proof mechanisms are likely to be fairly complex in view of the
multiplicity of stakeholders.
While the paper has provided very important new insights on the optimal design of
universal service policies, there is a lot more work to be done to corner all the relevant
issues. For instance, the relevance of uncertainty on the cost as well as on the demand side
of the regulated sectors are important considerations we have not yet been able to address.
Similarly, we have only hardly touched upon the importance of the imposition of a budget
balance constraint on the operators. These and other concerns are clearly important and
will have to be addressed as part of follow up research intended to test the robustness of
the conclusions presented here.
Acknowledgements
We thank Jean Tirole for his very detailed comments and suggestions. We are also very
grateful to two anonymous referees and Dr. Robin Boadway for their very helpful
suggestions. All remaining errors are our own and should not be attributed to any of the
institutions we are affiliated with.
Appendix
Proof of Proposition 1. The first-order conditions with respect to q̄ 1, q̄ 2, l̄ (and similarly
for those with respect to q 1, q 2, l ) are:
–
a1 ðSVq̄
ðq 1 Þ þ kp̄ q 1 þ kp̄
p 1Vq̄ p 1 Þ ð1 þ kÞa1 c1 ¼ 0 ð15Þ
l ðSVq̄
a2 l̄ ðq 2 Þ þ kp̄ q 2 þ kp̄
p 2Vq̄ p 2 Þ ð1 þ kÞa2 l̄
l c̄c 2 ¼ 0 ð16Þ
a2 ðS ðq̄
q 2 Þ þ kp̄ q 2 Þ ð1 þ kÞða2 c̄c 2 q̄
p 2 q̄ q 2 þ CVðl̄
l ÞÞ ¼ 0: ð17Þ
Since CWN 0, a sufficient condition for the concavity of the objective function is |SW|
large enough.
The determination of p̄ 2 and l̄ is illustrated in Fig. 1.
Eq. (16) determines q̄ 2 according to the Ramsey rule.18 For this level of q̄ 2, (17)
determines l̄.
18
There is of course an one to one relationship between p̄ 2 and q̄ 2.
Fig. 1. Optimal regulation under price discrimination: full information.
Since q̄ *2 maximizes S( q *2 ) + kp *2 q *2 (1 + k)c 2q *2 , we have S(q *2 ) + kp *q 2 *

2 (1 +
k)c̄ 2 q̄ 2 N S (q̄ 2 )+kp̄ 2 q̄ 2 (1 + k)c 2 q̄ 2 . But S (q̄ 2 ) + kp̄ 2 q̄ 2 (1 + k) c 2 q̄ 2 NS (q̄ 2* )+
* * * * * * * *
kp̄*2 q̄*2 (1 + k)c̄ 2q̄*2 . We thus have CV(l̄*) N CV(l̄*), which leads to l * N l̄* since we
–
assume CWN 0.
dlT
T the optimal condition for l̄* with respect to k we have ð1 þ kÞCW dk ¼

Differentiating
T
a2 p2 c2 q2 CVso that the RHS is negative. From first order conditions p 2* N c 2
Then, a sufficient condition for dlT dk b0 is that CVis large enough. 5
Proof of Proposition 2. Since only q̄ 2 and l̄ are affected by asymmetric information, we

only consider the first-order conditions with respect to q̄ 2 and l̄:
mka2 Dc2 l̄
l þ ð1 mÞ½a2 ðSVðq̄
q 2 Þ þ kp̄ q 2 þ kp̄p 2 Þ ð1 þ kÞa2 c̄c 2 l̄
p 2 Vq̄ l¼0 ð18Þ
q 2 þ ð1 mÞ½a2 ðS ðq̄
mka2 Dc2 q̄ q 2 Þ þ kp̄ q 2 Þ ð1 þ kÞða2 c̄c 2 q̄q 2 þ CVðl̄
p 2 q̄ l ÞÞ ¼ 0
ð19Þ
|SW| large enough ensures concavity.
Denote
U ðc2 ; c̃c 2 Þut ðc̃c 2 Þ þ a1 p1 ðc̃c 2 Þqðp1 ðc̃c 2 ÞÞ þ a2 lðc̃c 2 Þp2 ðc̃c 2 Þqðp2 ðc̃c 2 ÞÞ
ða1 c1 qðp1 ðc̃c 2 ÞÞ þ a2 c2 lðc̃c 2 Þqðp2 ðc̃c 2 ÞÞÞ C ðlðc̃c 2 ÞÞ

as the utility the firm obtains when its report about c 2 is c̃ 2. Proceeding as if c 2 was a
continuous variable, the first-order condition for truth-telling is:
ṫt þ a1 ðṗ
p 1 q1Vp1 þ ṗ
p 1 q1 Þ þ a2 l̇
lp2 q2 þ a2 lðq2 ṗ
p 2 þ p2 ṗp 2 q2V Þ
ða1 c1 q1Vṗ lq2 þ lq2Vṗ
p 1 þ a2 c2 ðl̇ p 2 ÞÞ CVðlÞl̇
l ¼ 0:
The second-order condition for truth-telling is:
lq2 þ lq2Vṗ
a2 ðl̇ p 2 Þz0:
Since q 2Vb 0, a sufficient second-order condition is l̇ b 0 and ṗ 2 N 0. So, the strategy is to

solve the problem in the absence of the second-order condition and check ex post that the
sufficient condition l̇ b 0 and ṗ 2 N 0 is satisfied (see Guesnerie and Laffont (1984)).
We can easily represent the impact of asymmetric information on Fig. 1 by looking at
Eqs. (18) and (19). We obtain Fig. 2.
Therefore p̄ 2SBNp̄*2 N p*2 =p̄ 2SB. Since q̄*2 maximizes S( q 2)+kp 2q 2(1+k)c̄ 2q 2 from (16),
we have S(q̄*2 )+kp̄*2 q̄*2 (1+k)c̄ 2q̄*2 zS(q̄ 2SB)+kp̄ 2SBq̄ 2SB(1+k)c̄ 2q̄ 2SBNS(q̄ 2SB¯)+kp̄ 2SBq̄ 2SB(1+
k)c̄ 2q̄ 2SBk 1m
m
Dc 2q̄ 2SB. We thus have CV(l̄*)NCV(l̄SB), which leads to l̄ *Nl SB. So l̄ SB bl *=
–
l . That is the second-order condition of incentive compatibility is satisfied. 5
SB
–
Proof of Proposition 3. The first-order conditions with respect to q̄ and l̄ are:
ða1 þ a2 l̄l ÞðSVðq̄
q Þ þ kp̄ q þ kp̄
pVq̄ p Þ ð1 þ kÞða1 c1 þ a2 c̄c 2 l̄
lÞ ¼ 0 ð20Þ
a2 ðS ðq̄
q Þ þ kp q Þ ð1 þ kÞða2 c̄c 2 q̄
P q þ CVðl̄
l ÞÞ ¼ 0: ð21Þ
From second-order conditions, the objective function is concave if the following
conditions are satisfied:
ða1 þ a2 l̄
l ÞðSWðq̄
q Þ þ kp̄ q þ 2kp̄
pWq̄ pVÞb0
2
a1 a2 ð c 1 c 2 Þ
CWðl̄
l Þða1 þ a2 l̄
l ÞðSWðq̄
q Þ þ kp̄ q þ 2kp̄
pWq̄ p ÞNð1 þ kÞ :
a1 þ a2 l̄l
So a sufficient condition for the concavity of the objective function is |SW| large enough.
Since a1ac11 þa 2 c2 l
þa2 l b c 2, TTwe have p̄**bp̄*2 and p **Np*. 2 Moreover, since p̄ * 2 maximizes
S ðq̄
q 2 Þþkp̄ p 2 q̄
q2 SVðq̄
q Þþkp̄p TT Vq̄
q TT þkp̄
p TT
1þk c̄ q̄
2 2 and 1þk c̄ 2 b 0 by substituting the first-order conditions, one
dp̄p c1
obtains that l̄** b l̄*. Similarly, – l ** b l *. Finally, we can show that dl̄
l ¼ k 1
1 1þk
p–
a1 a2 ðc̄c 2 c1 Þ
ða1 þa2 l̄ lÞ 2 N 0 and CW(l̄) dq̄
dl̄
l
q ¼a 2
SVðq̄
q Þþkp̄
1þkÞ
pVq̄
qþkp̄
c̄c 2 b0: Therefore both the pricing curve and
g
the network coverage curve are increasing functions of p̄.
Fig. 2. Optimal regulation under price discrimination: asymmetric information.

Differentiating the following equations with respect to c 2:

a1 c 1 þ a2 c 2 l
p
a1 þ a2 l k 1
¼
p 1þk g

S ðqÞ þ kpq
ð Þ ¼ a2
CVl c2 q ;
1þk
we have:

dl dq SV þ kpVq þ kp ð1 þ kÞc2
CW ¼ a2 q
dc2 dc2 1þk
dl
ða1 þ a2 lÞa2 l þ a1 a2 ðc2 c1 Þ
dq qV dc2
¼ :
dc2 k
1 1þk 1
g ða1 þ a2 lÞ2
dq dl
Then one can solve for dc and dc :
2 2 2 3
dq 1 qVlCW a1 a2 ðc2 c1 ÞqqV
¼ 4 þ 5
dc2 D k 1
1 1þk g ða1 þ a2 lÞ k 1
1 1þk ð a 1 þ a 2 lÞ 2
g
2 3
dl 14 a2 qVlðSVq
ð Þ þ kpVq þ kp ð1 þ kÞc2 Þ 5
¼ q ;
dc2 D 1 k 1 ða1 þ a2 lÞð1 þ kÞ
1þk g
dq dl
where D ¼ CW a2 þ
a1 a2 qVðc2 c1 ÞðSVðqÞþkpVqþkpð1þkÞc2 Þ
k 1 ða þa lÞ2 ð1þkÞ
ð1 1þk
: A sufficient condition for dc \0 and dc \0
gÞ 1 2 2 2
is both CW and a 1 are large enough, which ensure that the paper will focus on the
interesting case where p̄** > p ** and l̄** b l**. We obtain Fig. 3.
For c̄ 2 not too large with respect to c 1, the curves ¯ associated with Eqs. (20) and (21) cut
as shown in Fig. 3. An increase of c̄ 2 as shown in the figure has ambiguous effects unless
Fig. 3. Optimal regulation under uniform pricing.

CW and a 1 are large enough. Then the second order condition are satisfied and the solution
is as described in Proposition 3. 5
Proof of Proposition 4. The first-order conditions are:
l þ ð1 mÞ½ða1 þ a2 l̄
mka1 Dc2 l̄ l ÞðSVðq̄
q Þ þ kp̄pVq̄q þ kp̄p Þ ð1 þ kÞ
ða1 c1 þ a2 c̄c 2 l̄
l Þ ¼ 0
q þ ð1 mÞ½a2 ðS ðq̄
mka1 Dc2 q̄ q Þ þ kp
Pq Þ ð1 þ kÞða2 c̄c 2 q̄q þ CVðl̄
l ÞÞ ¼ 0:
One can show that a sufficient condition for the concavity of the objective function is
|SW| large enough.
Denote U(c 2 , c̃ 2 ) u t(c̃ 2 ) + (a 1 + a 2 l(c̃ 2 ))p( q(c̃ 2 ))q(c̃ 2 ) (a 1 c 1 + a 2 c 2 l(c̃ 2 ))q(c̃ 2 )
Cl(c̃ 2)) as the firm’s utility when c̃ 2 is its report about c 2. The first-order condition for
truth-telling is (for a continuous variable c 2):
lpðqÞq þ ða1 þ a2 lÞð pVq̇

ṫt þ a2 l̇ qq þ pq̇
q Þ a2 c2 l̇
lq ða1 c1 þ a2 c2 lÞq̇q CVðlÞl̇
l ¼ 0:
The second-order condition is:
lq a2 lq̇
a2 l̇ qz0:
A sufficient condition for the second-order condition to be satisfied is p̄ USB N p USB and
l̄USB b l USB, which implies:
–
l USB
a1 c1 þ a2 c̄c 2 l̄ k m l USB a1 c1 þ a2 P
a2 Dc2 l̄ l**
c 2P
USB
þ N
a1 þ a2 l̄
l 1 þ k 1 m a1 þ a2 l̄ l USB a1 þ a2 P l**
USB
S q̄
q p USB q̄
þ kp̄ q USB k m
q USB c̄c 2
q̄ Dc2 q̄q USB
1þk 1þk 1m

S q** þk p** q**
b P P P
q**c 2:
1þk P P
Thus a sufficient condition for the second-order condition of truth telling to be satisfied
is Dc 2 large enough. However, if Dc 2 small enough, we have p̄ USB b p USB and
l̄ USB b l USB. Then bunching occurs so that p̄ USB = p USB = p USB and l̄ USB = l– USB=l USB.
–
Let us now compute the condition that ensures p̄ USB N p̄** and l̄ USB b l̄ **. From the
first-order conditions we have:
l USB
a1 c1 þ a2 c̄c 2 l̄ k m l USB a1 c1 þ a2 c̄c 2 l̄
a2 Dc2 l̄ l TT
USB
þ USB
N
a1 þ a2 l̄
l 1 þ k 1 m a1 þ a2 l̄
l l TT
a1 þ a2 l̄
or p̄ USB N p̄** ifUSBDc 2 is large enough. Similarly, l̄USB b l̄** if Dc 2 is large enough Finally,
a1 c1 þa2 c̄c 2 l̄
l k l USB
m a2 Dc2 l̄ k m
since a þa l̄l USB þ 1þk 1m a þa l̄l USB is always smaller than c̄ 2+ 1þk 1m Dc2 ; we have
1 2 1 2
S ðq̄q 2 Þþkp̄p 2 q̄q 2
p̄ USB b p̄ 2SB. Moreover, since p̄ 2SB optimizes 1þk
k
q̄q 2 c̄c 2 1þk m
1m Dc2 q̄q 2 ; we have
l̄ USBb l̄ SB. 5
Proof of Proposition 6. Define q̄ uc = q(c 2 = c̄ 2, r = c̄ 2), q uc = q(c 2 = c̄ 2, r = c 2), q̄ uc/ =

q(c 2 = c 2 ,r = /), and q uc/ = q(c 2 = c 2, r = /). Other notation such as l uc , l uc/ , l̄uc , and
– –
l¯uc/ is similarly defined.
If c 2 = c 2 and r = c 2 the good type firm will get an information rent of a 2Dc 2l̄c/ q̄ c/ if
the regulator hides the information. Thus the government has to satisfy the following
collusion-proofness constraint to induce truth-telling by the regulator:
P
l uc/ q̄
s uf [k1 a2 Dc2 l̄ q uc/ : ð22Þ
As with discriminatory pricing, rural consumers do not have any stake in collusion
because neither the price nor the size of the network is distorted if c 2 = c̄ 2. Since c 1 is
common knowledge, urban consumers cannot collude with the regulator, even though they
are adversely affected by uniform pricing. Similarly, taxpayers will pay the same amount
of taxes regardless of the regulator’s report.
Suppose the state of nature is c 2 = c̄ 2 and r = c̄ 2. The firm does not have any stake in
collusion any more because it does not get any information rent when c 2 = c̄ 2. We know
from Proposition 4 that when asymmetric information is large enough, the price for the
rural area is higher and the network smaller if the regulator hides his information. Thus
a 2l̄ uc (S(q̄ uc ) p̄ uc q̄ uc ) N a 2l̄uc/ (S(q̄ uc/ ) p̄ uc/ q̄ uc/ )—that is, rural consumers obtain less
surplus if the regulator does not report truthfully, so they have no incentive to collude.
Similarly, collusion between urban consumers and the regulator is not an issue in this state
of nature.
Note that taxpayers pay Tuc = (a 1c 1 + a 2c̄ 2l̄uc )q̄ uc (a 1 + a 2l̄uc )p̄ uc q̄ uc + C(l̄uc ) if the
signal is revealed and Tuc/ = (a 1c 1 + a 2c̄ 2l̄uc/ )q̄ uc/ (a 1 + a 2l̄uc/ )p̄ uc/ q̄ uc/ +C(l̄uc/ ) if
not. Since (a 1c 1 + a 2c̄ 2l)q (a 1 + a 2l)pq + C(l) N 0 if CV(d ) is large enough, the taxpayers
save a tax payment of Tuc Tuc/ N 0 if the regulator reports r = /. So they have incentives
to collude with the regulator. Thus the government needs to satisfy the following
collusion-proofness constraint:

ss̄ ut [k2 ða1 c1 þ a2 c̄c 2 l̄
l uc Þq̄
q uc ða1 þ a2 l̄
l uc Þp̄
p uc q̄q uc þ C ðl̄
l uc Þ a1 c1 þ a2 c̄c 2 l̄
l uc/ q̄q uc/
uc/ uc/ uc2/
l uc/ p̄
þ a1 þ a2 l̄ p q̄ q C l̄ l : ð23Þ
First-order conditions lead to the following result:
p uc ¼ p uc/ ¼ l**; l uc ¼ l uc/ ¼ l**

P P P P P P

c/ l c/
a1 c1 þ a2 c̄c 2 l̄ k n
p
p̄ 1 k2
l c/
a1 þ a2 l̄ 1þk 1n
¼
p c/
p̄

k 1 k n 1 k m 1 l uc/ 1
a2 Dc2 l̄
þ k2 1 þ
1þk g 1þk 1n g l uc/ pp̄ uc/
1 þ k 1 m 1 n a1 þ a2 l̄
½nk1 þ ð1 nÞ

uc l uc
a1 c1 þ a2 c̄c 2 l̄ k
p
p̄ 1 k2
l uc
a1 þ a2 l̄ 1þk k 1 k 1
¼ k2 1
p uc
p̄ 1þk g 1þk g

uc/ k n
CV l̄
l 1 k2
1þk 1n
"
q uc/ þ kp̄
S q̄ p uc/ q̄
q uc/ k m q̄q uc/ Dc2
¼ a2 q c/
c̄c 2 q̄ ð k 1 n þ ð 1 nÞ Þ
1þk 1þk 1m 1n

k n uc/
q uc/ p̄
k2 q̄ p c̄c 2
1þk 1n

uc k n
CVðl̄
l Þ 1þ k2
1þk 1n

q uc Þ þ kp̄
S ðq̄ p uc q̄
q uc k
¼ a2 q uc þ
c̄c 2 q̄ k2 q̄q uc ðp̄p c c̄c 2 Þ : 5
1þk 1þk
References
Chisari, O., Estache, A., Waddams-Price, C., 2003. Access by the poor in Latin America’s utility reform:
subsidies and service obligations. In: Ugaz, C., Waddams-Price, C. (Eds.), Utility Privatization and
Regulation: a Fair Deal for Consumers? Edward Elgar, Northampton, MAS, USA.
Clark, G., Wallsten, S., 2002. Universal(ly Bad) Service: Providing Infrastructure Services to Rural and Poor
Urban Consumers. Policy Research Working Paper, vol. 2868. World Bank.
Cremer, H., Gasmi, F., Grimaud, A., Laffont, J.-J., 2001. Universal service: an economic perspective. Annals of
Public and Cooperative Economics 71, 5 – 42.
Estache, A., Laffont, J.-J., Zhang, X.-Z., 2003. Universal service obligations in developing countries. Working
Paper, Research Center for Regulation and Competition, Beijing.
Gasmi, F., Laffont, J.-J., Sharkey, W., 1999. Competition, universal service and telecommunications policy in
developing countries. Information Economics and Policy 12, 221 – 248.
Guesnerie, R., Laffont, J.-J., 1984. A complete solution to a class of principal–agent problems with an application
to the control of self-managed firm. Journal of Public Economics 25, 329 – 369.
Laffont, J.-J., Martimort, D., 2002. The Theory of Incentives I: The Principle–Agent Model. Princeton University
Press, Princeton.
Laffont, J.-J., N’Gbo, A., 2000. Cross-subsidies and network expansion in developing countries. European
Economic Review 44, 797 – 805.
Laffont, J.-J., Tirole, J., 1993. A Theory of Incentives in Procurement and Regulation. MIT Press, Cambridge.
Laffont, J.-J., Tirole, J., 2002. Competition in Telecommunications. MIT Press, Cambridge.
Maskin, E., 1999. Nash Equilibrium and Welfare Optimality. Review of Economic Studies 66, 23 – 38.
Tirole, J., 1986. Hierarchies and Bureaucracies. Journal of Law, Economics, and Organization 2, 181 – 214.

Universal Service Obligations in LDCS: The Effect of Uniform Pricing On Infrastructure Access

Caricato da

Informazioni sul documento

Titolo originale

Copyright

Formati disponibili

Condividi questo documento

Condividi o incorpora il documento

Opzioni di condivisione

Hai trovato utile questo documento?

Questo contenuto è inappropriato?

Copyright:

Formati disponibili

Universal Service Obligations in LDCS: The Effect of Uniform Pricing On Infrastructure Access

Caricato da

Copyright:

Formati disponibili

Journal of Public Economics 90 (2006) 1155 – 1179

Universal service obligations in LDCs: The effect of

JEL classification: L43; D82; O12

2. The basic setting

Consider a simple principal–agent relationship between a benevolent government and a

3. Optimal regulation under price discrimination

Optimal regulation then entails:

ð1 þ kÞC Vðl̄ q*2 Þ þ kp̄

Proof. See the Appendix. 5

fp1 ðc̃c 2 Þ; p2 ðc̃c 2 Þ; lðc̃c 2 Þ; t ðc̃c 2 Þg with c̃c 2 afP

where c̃ 2 is the monopolist’s report to the government about its c 2.

and for the low-cost (good-type) firm:

Thus the government’s program is:

s.t. (4), (5), (6), and (7).

Proof. See the Appendix. 5

Under asymmetric information the regulator has to give up an information rent

4. Optimal regulation under uniform pricing

and for the low-cost (good-type) firm:

The government optimizes the following objective function:

ðS ðq̄ Pq Þ ð1 kÞ½ða1 c1 þ a2 lPc 2 Þq̄q þ C ðl̄

subject to constraints (8) and (9).

Then optimal regulation entails:

Proof. See the Appendix. 5

and for the low-cost (good-type) firm:

i) If c 2 = c 2 , the optimal regulatory rule is the same as under complete information

Proof. See the Appendix. 5

5. Universal service policy under collusion

We now consider the possibility of collusion, to illustrate in a very simple setting

RðsÞ ¼ s and sz0; ð12Þ

as l c , l c/ , l̄ c , and l̄c/ is similarly defined.

subject to constraints (7–10),(13), and (14).

We thus obtain the following result:

More specifically, the optimal regulatory policy entails:

Proof. The proof of Proposition 5 is straightforward so it is omitted. 5

Proof. See the Appendix. 5

information asymmetries by adopting, for instance, regulatory accounting guidelines,

Fig. 1. Optimal regulation under price discrimination: full information.

Since q̄ *2 maximizes S( q *2 ) + kp *2 q *2 (1 + k)c 2q *2 , we have S(q *2 ) + kp *q 2 *

Proof of Proposition 2. Since only q̄ 2 and l̄ are affected by asymmetric information, we

ða1 c1 qðp1 ðc̃c 2 ÞÞ þ a2 c2 lðc̃c 2 Þqðp2 ðc̃c 2 ÞÞÞ C ðlðc̃c 2 ÞÞ

Since q 2Vb 0, a sufficient second-order condition is l̇ b 0 and ṗ 2 N 0. So, the strategy is to

the network coverage curve are increasing functions of p̄.

Fig. 2. Optimal regulation under price discrimination: asymmetric information.

Differentiating the following equations with respect to c 2:

Fig. 3. Optimal regulation under uniform pricing.

lpðqÞq þ ða1 þ a2 lÞð pVq̇

The second-order condition is:

Proof of Proposition 6. Define q̄ uc = q(c 2 = c̄ 2, r = c̄ 2), q uc = q(c 2 = c̄ 2, r = c 2), q̄ uc/ =

First-order conditions lead to the following result:

p uc ¼ p uc/ ¼ l**; l uc ¼ l uc/ ¼ l**

Potrebbero piacerti anche

Since q̄ 2 maximizes S( q 2 ) + kp 2 q 2 (1 + k)c 2q 2 , we have S(q 2 ) + kp q 2

p uc ¼ p uc/ ¼ l; l uc ¼ l uc/ ¼ l