Regulating a Monopolist with Unknown Demand: Costly Public Funds and the Value of Private Information

In this paper, we analyze the optimal regulation policy when the regulated firm has better information concerning the market demand than the regulator. We show that introducing a cost on public funds into the Planner's objective function does not lead to qualitative results similar to those obtained by introducing distributional considerations. In particular we show that under constant marginal cost the full information policy is not implementable and that the optimal regulatory policy results in informational rents. The social value of private information and the firm's informational rents are both increasing functions of the cost of the public funds. Copyright 2004 Blackwell Publishing Inc..