Screening Mechanism Design¶
Why It Matters¶
Signaling puts the burden on the sender and may fail if senders don't know how to signal effectively. Screening puts the receiver in control - you design the test rather than waiting for signals. This is often more efficient and reliable when you're the party making decisions based on type.
The Key Move¶
To screen, design a menu of options with different cost-benefit structures. High types should prefer option A (pays high cost for high benefit); low types should prefer option B (pays low cost for low benefit). Make sure the high-benefit option is unattractive to low types (benefit doesn't outweigh cost). Observe which they choose, infer their type.
Classic Application¶
Insurance contracts with deductibles. Insurers can't observe who's accident-prone. Solution: offer high-deductible policies (cheap premiums) and low-deductible policies (expensive premiums). Safe drivers prefer high-deductible (they don't expect claims); risky drivers prefer low-deductible (they expect claims and value coverage). The choice reveals private information about risk type without the insurer directly observing it.
Surprising Application¶
Product line versioning. Software companies sell premium and basic versions of the same product. The premium version costs more but has features professional users value. The basic version is deliberately crippled to be unattractive to professionals but fine for casual users. This is screening: professionals self-select into high price, casuals into low price, and the company extracts more surplus than with uniform pricing. The "damaged goods" are intentional.
Failure Modes¶
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Poorly designed menus: if both types prefer the same option, screening fails. The options must be sufficiently differentiated that types separate.
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Ignoring budget constraints: if low types can't afford even their designated option, they don't participate. Screening requires feasibility for all types.
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Revealing the mechanism: if people understand they're being screened, they may game the test (choose strategically rather than revealing type). Some screening works best when opaque.
Go Deeper¶
- Rothschild & Stiglitz, "Equilibrium in Competitive Insurance Markets" - screening via contract design
- Varian, "Price Discrimination" in Microeconomic Analysis - product versioning as screening