| Part I of this essay adds two innovations to a standard Baron and Myerson Principal Agent game of incomplete information where the agent's private information is the marginal cost of production, which increases with {dollar}theta.{dollar} Not only do we include the abatement cost, but we also allow a divergent impact of {dollar}theta{dollar} on the marginal cost of abatement and production. This leads to below marginal cost pricing to ensure incentive compatibility for some {dollar}theta{dollar} where a phenomenon called Strong Divergence occurs.; The second innovation is the introduction of the agent's investment decision and expansion into a two-stage game. The investment decision affects the total cost, and the Principal's beliefs about {dollar}theta.{dollar} So the Agent, anticipating the mechanism, chooses investment to lower total cost, but also to manipulate the information asymmetry. This leads to under-investment for some {dollar}theta{dollar} where Strong Divergence occurs, and over-investment otherwise.; Part II of this essay deals with mechanism design under common agency, which is useful whenever the problem involves an agent's private information and some degree of competition among multiple principals contracting with the same agent. In this type of three (or more) person game, the pure strategy Nash Equilibrium is complicated by the strategic revelation effect. This game has been investigated theoretically by Stole (1990). We have derived a simpler version of Stole's theoretical results and implement it computationally, so the contracting level of activities under full information, under cooperative framework, and under common agency, can be easily calculated and compared. |
