Market power, randomization and regulation

This paper provides an introduction to and overview of the mechanism design approach to textbook monopoly and monopsony pricing problems. Specifically, assuming that agents are privately informed about their values and costs, it shows that the optimal selling and procurement mechanisms quite generally involve rationing, provided the underlying mechanism design problem does not satisfy the regularity assumption of Myerson (1981). Rationing takes the form of underpricing in the case of a monopoly seller and of involuntary unemployment and efficiency wages in the case of a monopsony employer. The paper illustrates these phenomena, as well as the effects of price ceilings and minimum wages, with a leading example that permits closed-form solutions. It also explains why resale tends to undermine the firm's benefits from rationing without eliminating them and discusses emerging issues for the theory of regulation.