What is the incentive compatibility problem? Give an example. A problem that ari

Question

What is the incentive compatibility problem? Give an example. A problem that arises when government intervention does not improve the well being of society. An example is when a government employee hires friends to do contract work instead of bidding contracts out and choosing the lowest bid. A problem in which the incentive to engage in an activity is realized now while the costs are realized later. This separation of incentive sand costs creates a problem because people tend to discount future costs and benefits. An example is someone who chooses not to exercise but later regrets the weight gain. A problem that arises when the incentive facing a decision maker (marginal benefit) does not equal the effort (marginal cost). An example is when government places a greater cap on CO_2 than is efficient (the costs of reducing emissions exceed the benefits). A problem in which the incentive facing the decision maker does not match the incentive needed for the mechanism to achieve its desired end. An example is the salary of managers. While it is the interest of the corporation of keep costs down (keep salaries as low as possible), it is in the interest of the manager to boost his own salary.

Explanation / Answer

Incentive compatibility problem arises when the incentive facing the decision maker does not match incentives to achieve the goals of the mechanism as a whole. An example is where the manger of a firm wishes to maximize his salary and perks, while it is in the interest of the owner of the firm to minimize the costs.

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