Mechanism Design with Costly Inspection

Amirreza Ahmadzadeh and Stephan Waizmann
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Amirreza Ahmadzadeh: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - Comue de Toulouse - Communauté d'universités et établissements de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement
Stephan Waizmann: PUC - Pontificia Universidad Católica de Chile = Pontifical Catholic University of Chile [Santiago]

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Abstract: This paper studies how to combine screening menus and inspection in mechanism design. A Principal procures a good from an Agent whose cost is his private information. The Principal has three instruments: screening menus —i.e., quantities and transfers — and (ex-ante) inspection. Inspection is costly but reveals the Agent's cost. The combination of inspection and screening menus mitigates inefficiencies: the optimal mechanism procures an efficient quantity from all Agents whose cost of production is sufficiently low, regardless of whether inspection has taken place. However, quantity distortions still necessarily occur in optimal regulation; the quantity procured from Agents with higher production costs is inefficiently low. Both results are true regardless of the magnitude of inspection costs. In contrast to settings without inspection, incentive compatibility con-straints do not bind locally. This paper provides a method to address this challenge, characterizing which constraints bind.

Keywords: Mechanism Design; Verification; Principal-Agent; Inspection; Procurement (search for similar items in EconPapers)
Date: 2026-08-27
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