An Incentive-Compatibility Approach to the Problem of Monitoring a Bureau

An incentive-compatibility framework for regulating a monopolist with unknown costs is applied to the sponsor’s problem of monitoring a bureau. Following Mueller (1989), the bureau does not make take-it-or-leave-it budget proposals to the sponsor. Rather, the bureau must announce a marginal cost per unit of output to the sponsor. Given that report, the sponsor chooses a price that it will pay to the bureau for each unit of output, and the sponsor chooses the level of output as well. The analysis reveals the price per unit of output that the sponsor must pay to the bureau to maximize social welfare.