Think of a state where the regulator is uncertain as to the true cost of the regulated firm. Also, the firm (the firm's management) can work harder or less hard to control costs; if it doesn't work hard its costs will be higher. There is a subjective cost to work hard to keep costs down, e.g., due to  management will have to fire a lot of staff and it will have to introduce new work routines that will not be popular. This is a real & substantial cost, but it doesn't show up in the accounts, it cannot be verified and thus it cannot be compensated explicitly by the regulator.

a) Discuss the trade-off the regulator has to make among cost control and rent extraction. What "family" of regulatory methods will achieve cost control, what "family" of methods will achieve rent extraction? Can the two methods be combined?

b) Under a consumer-welfare standard, try to construct two instances where one of the 2 methods is preferred in one example and the other in the other example. Try to link your two examples to real-world situations!