Bidirectional Distortion in Self-Selection Problems.

This paper considers assumptions on consumer heterogeneity that can generate bidirectional distortion in a model of quality discrimination. It is shown that the profit-maximizing strategy can involve the simultaneous degradation of quality at the low end of the spectrum, while quality enhancement occurs at the high end. The implications of this result for optimal income taxes and incentive regulation are drawn out. It is argued that the welfare losses of quality distortion are likely to be lower under bidirectional distortion than under the unidirectional distortion derived in the literature. Copyright 1992 by Blackwell Publishing Ltd.