Incomplete Regulation, Competition and Entry in Increasing Returns to Scale Industries

The paper analyzes the effects of liberalization in increasing returns to scale industries. It studies the optimal regulation of an incumbent competing with an unregulated strategic competitor, when public funds are costly. The model shows a trade off between productive and allocative efficiency. Moreover, the welfare gains of liberalization, as compared with regulated monopoly, are a non monotonic function of the cost of public funds. Finally, in the case of severe cash constraint of the government, incomplete regulation may also dominate full regulation of duopoly.