Consider a regulator’s objective formulized as:

(a) Show that at most one of the four constraints (incentive compatibility and participation) can be binding in this case, that the high cost firm’s fee is always positive, and, therefore, that the low cost firm’s participation constraint is always satisfied (since it receives additional money from the high cost firm).

(b) Derive the optimality conditions for the different cases where either one of the incentive constraints, or the H-type firm’s participation constraint, is binding.

(c) Describe a numerical example for each of the three cases.

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max eL.CH.TL.TH {JB K C(e,S) (J K) C(S) D(Ke +(J K))}, subject to the balanced budget constraint KT +(JK)T =0.