Application of the Baron-Myerson monopolist regulation mechanism: issues on selecting the cost probability distributions
Dezerega, Alejandro Bartolome
Terasawa, Katsuaki L.
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The end of cold war levels of defense expenditures has promoted the reduction in the number of defense-related companies, creating potential monopolistic economic scenarios for defense procurement. This thesis studies one methodology to deal with these scenarios, based on the Baron-Myerson monopolist regulation mechanisms. The Baron-Myerson mechanism provides a tool to regulate monopolists when their costs are unknown or cannot be measured, because it is designed as to compel the producer to reveal its costs by maximizing the company's profit when it announces their true value. The government presents a modified purchasing plan to the producer, buys according to the announced costs and pays a subsidy (or levies a tax) to the producer. To apply Baron-Myerson the government needs to know the demand for the good or service it requires, and an estimate of probability density function for the possible costs of the project. This second assumption is the issue addressed in this thesis. The thesis establishes selection criteria and policy recommendations that the government can use to choose a probability density function for the application of Baron-Myerson. The criteria is based on the maximization of the expected government gain, given the level of efficiency of the producer. Also, an analysis of the policy implications of the government's choice is made, to determine the effects of a change in policy on the total welfare, the firm's profits and the government gain.
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