Mechanism Design with Financially Constrained Agents and Costly Verification

124 Pages Posted: 7 Feb 2017

See all articles by Yunan Li

Yunan Li

City University of Hong Kong (CityUHK)

Date Written: January 18, 2017


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.

Keywords: Mechanism Design, Budget Constraints, Efficiency, Costly Verification

JEL Classification: D45, D61, D82, H42

Suggested Citation

Li, Yunan, Mechanism Design with Financially Constrained Agents and Costly Verification (January 18, 2017). PIER Working Paper No. 17-001. Available at SSRN: or

Yunan Li (Contact Author)

City University of Hong Kong (CityUHK) ( email )

83 Tat Chee Avenue
Hong Kong

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