Adverse Selection Problems Without the Spence-Mirrlees Condition

41 Pages Posted: 27 Sep 2013

See all articles by Aloisio Araujo

Aloisio Araujo

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças

Humberto Moreira

Fundacao Getulio Vargas (FGV)

Date Written: May 24, 2010

Abstract

This paper studies a class of one-dimensional screening problems where the agent's utility function does not satisfy the Spence-Mirrlees condition (SMC). The strength of the SMC for hidden information problems is to provide a full characterization of implementable contracts using only the local incentive compatibility (IC) constraints. These constraints are equivalent to the monotonicity of the decision variable with respect to the agent's unobservable one-dimensional parameter. When the SMC is violated the local IC constraints are no longer sufficient for implementability and additional (global) IC constraints have to be taken into account. In particular, implementable decisions may not be monotonic and discretely pooled types must have the same marginal utility of the decision (or equivalently, get the same marginal tariff). Moreover, at the optimal decision, the principal must preserve the same trade-off between rent extraction and allocative distortion measured in the agent's marginal rent unit. In a specific setting where non-monotone contracts may be optimal we fully characterize the solution.

Keywords: Spence-Mirrlees condition, Global incentive compatibility, U-shaped condition, Discrete pooling

JEL Classification: H41, D82

Suggested Citation

Araujo, Aloisio and Moreira, Humberto, Adverse Selection Problems Without the Spence-Mirrlees Condition (May 24, 2010). Journal of Economic Theory, Vol. 145, No. 3, 2010, Available at SSRN: https://ssrn.com/abstract=2330464

Aloisio Araujo (Contact Author)

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças ( email )

Praia de Botafogo 190/1125, CEP
Rio de Janeiro RJ 22253-900
Brazil

Humberto Moreira

Fundacao Getulio Vargas (FGV) ( email )

R. Dr. Neto de Araujo 320 cj 1307
Rio de Janeiro, Rio de Janeiro 22250-900
Brazil

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