ENCS473 Lecture Notes - Lecture 9: Incentive Compatibility, Nash Equilibrium

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Principal-agent model: two actions: reporting spill, cleanup; reporting effectiveness. Depends upon 2 differences: difference in probability that being diligent will lead to high returns and probability that being lax will lead to punishment, difference between payoffs associated with proper cleanup and payments associated with improper cleanup. Diligent (clean up and clean (good job) report accurately) polluted clean reporting success. Lax (cleanup and of cleanup reporting) polluted (bad job) Assume that p > p and t > t. Monitoring outcome = what the regulator/monitor decides your site is (adequately cleaned or polluted). Probability of outcome = the likelihood that the regulator/monitor comes to that conclusion. *more on constraints: participation constraint: a company has incentive to report (profit with reporting) > (profit without reporting) Incentive compatibility constraint: company has incentive to cleanup (be diligent) (profit with cleanup) > (profit without cleanup) The government (regulator) sets t, t, p, and p. Profit with reporting = p x t + (1+p)t > c.

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