A Game Theory Analysis of Social Cost

Yi-Lun Ding

Environmental regulators desire truthful reporting, but it is not necessarily the interest of industry to report truthfully. A solution to this problem of incentive compatibility is the Groves regulatory mechanism. Under the Groves mechanism, the regulated party maximizes his or her payoff when he or she reports truthfully; however, the mechanism also has its shortcomings.

This paper examines an alternative to the Groves mechanism. I derived the mechanism specifically for managing common property resources, such as fisheries and the atmosphere. I dub the alternative, the "mean reporter" mechanism, because it bases the tax or transfer utility rule on the report of the player with the mean amount of action, henceforth known as the mean player. This mechanism has a Nash equilibrium where the report of the mean player is the net social benefit maximizing report; however, this Nash equilibrium requires specific initial conditions. In this Nash equilibrium, the mechanism is budget-balanced but not efficient*.