Asymmetric Information

Question 1

Why is perfect information for the regulator important?

Answer 1

Firms have incentives to overstate costs

Question 2

What happens in the Loeb-Magat mechanism?

Answer 2

Monopolist chooses the price, the regulator guarantees a subsidy equal to the consumer surplus at the selected price

Question 3

How does the Loeb-Magat mechanism incentivise firms?

Answer 3

There is an incentive now to be allocatively efficient (P=MC) firms now maximise the total surplus

Question 4

What do regulators do with the subsidy in the L-M mechanism?

Answer 4

They cap the subsidy with (price ceiling Pr)
firms still choose P=MC

Question 5

What are some criticisms of the L-M mechanism?

Answer 5

Assumption of equal weighting between CS and PS might be unrealistic
Regulator might learn firms MC

Question 6

When is the Loeb Magat mechanism used?

Answer 6

When the cost function is only known to the monopolist

Question 7

When is the Baron and Myerson mechanism used?

Answer 7

When the cost function is only known to the monopolist

Question 8

What is the idea behind the Baron and Myerson mechanism?

Answer 8

Firms are either high cost or low cost.
Regulators compensate low-cost firms for producing on their MC and not choosing profit.

Question 8

What contract will the monopolist choose in the baron and myerson mechanism?

Answer 8

the contract that maximises:
π=PQ-θQ+T
T - transfer from compensation

Question 9

Draw a graph showing a Low cost and high cost firm in the Baron and Myerson mechanism.

Answer 9

check ppt 13

Question 10

What is the equation for the low cost firms profit?

Answer 10

check ppt 14

Question 11

What is the payment called when a low-cost firm prices on their MC curve and what does the payment depend o?

Answer 11

Information rent
Depends on gap between θH
and θL