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On the Pareto Efficiency of a Socially Optimal Mechanism for Monopoly Regulation

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  • Saglam, Ismail

Abstract

Baron and Myerson (BM) (1982)propose an incentive-compatible, individually rational and ex-ante socially optimal direct-revelation mechanism to regulate a monopolistic firm with unknown costs. We show that their mechanism is not ex-post Pareto dominated by any other feasible direct-revelation mechanism. However, there also exist an uncountable number of feasible direct-revelation mechanisms that are not ex-post Pareto dominated by the BM mechanism. To investigate whether the BM mechanism remains in the set of ex-post undominated mechanisms when the Pareto axiom is slightly weakened, we introduce the epsilon-Pareto dominance. This concept requires the relevant dominance relationships to hold in the support of the regulator's beliefs everywhere but at a set of points of measure epsilon, which can be arbitrarily small. We show that a modification of the BM mechanism which always equates the price to the marginal cost can epsilon-Pareto dominate the BM mechanism at uncountably many regulatory environments, while it is never epsilon-Pareto dominated by the BM mechanism at any regulatory environment.

Suggested Citation

  • Saglam, Ismail, 2016. "On the Pareto Efficiency of a Socially Optimal Mechanism for Monopoly Regulation," MPRA Paper 71090, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:71090
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    References listed on IDEAS

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    1. Koray, Semih & Sertel, Murat R., 1990. "Pretend-but-perform regulation and limit pricing," European Journal of Political Economy, Elsevier, vol. 6(4), pages 451-472.
    2. Vogelsang, Ingo, 1988. "A Little Paradox in the Design of Regulatory Mechanisms," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(3), pages 467-476, August.
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    5. Semih Koray & Ismail Saglam, 2005. "The Need for Regulating a Bayesian Regulator," Journal of Regulatory Economics, Springer, vol. 28(1), pages 5-21, July.
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    Keywords

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    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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