Does a Monopoly Need to Exclude?

Abstract

We examine the optimal selling strategy of a monopolist facing consumers who have privately known demands, and some of whom have limited abilities to misrepresent their preferences. We derive the optimal mechanism in this environment and characterize its properties. In particular, we show that communication with consumers plays a significant role in the process of screening. Consumers who have better abilities to misrepresent information benefit from the presence of consumers who lack such abilities. Whenever the fraction of the latter group of consumers is positive, there is no exclusion: It is optimal for the firm to supply a positive quantity of the good to all consumers whose valuations exceeds the marginal cost of production. Our analysis reflects the view that the environments where individuals can costlessly and effortlessly manipulate and misrepresent their private information, although standard in economics, represent an extreme point in the spectrum of various possibilities. In fact, available evidence suggests that at least some individuals have limited abilities to misrepresent their true types and imitate others' behavior.

Keywords: Mechanism design, screening, honesty, bounded rationality

JEL Classification: C72, D82