“Mechanism Design with Financially Constrained Agents and Costly Verification” by Yunan Li
City University of Hong Kong
A principal wishes to distribute an indivisible good to a population of budget-constrained
agents. Both valuation and budget are an agent’s private information. The principal can inspect
an agent’s budget through a costly verification process and punish an agent who makes a
false statement. I characterize the direct surplus-maximizing mechanism. This direct mechanism
can be implemented by a two-stage mechanism in which agents only report their budgets.
Specifically, all agents report their budgets in the first stage. The principal then provides budget-dependent
cash subsidies to agents and assigns the goods randomly (with uniform probability)
at budget-dependent prices. In the second stage, a resale market opens, but is regulated with
budget-dependent sales taxes. Agents who report low budgets receive more subsidies in their
initial purchases (the first stage), face higher taxes in the resale market (the second stage) and
are inspected randomly. This implementation exhibits some of the features of some welfare
programs, such as Singapore’s housing and development board.