Mechanism Design with Costly Inspection

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 two 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. In contrast to settings without inspection, incentive compatibility constraints do not bind locally. Nonetheless, the paper characterizes which incentive constraints bind.

Keywords

JEL codes

Reference

Amirreza Ahmadzadeh, and Stephan Waizmann, “Mechanism Design with Costly Inspection”, TSE Working Paper, n. 24-1533, May 2024, revised July 2026.