Regulating a Multiproduct Monopolist with Unknown Demand: Cross-Subsidization and Countervailing Incentives

This paper studies the regulation of a multiproduct monopolist that has private information about demand conditions. In particular, we consider the regulation of a two-product monopolist with interdependent demands when it has better information concerning the demand of one product than the regulator and public funds are costly. We show that the optimal regulation policy in this case crucially depends on whether goods are substitutes or complements. Cross-subsidization arises with demand complementarities, making it likely that countervailing incentives characterize the optimal contract.