Economies with observable types

We study economies of asymmetric information with observable types. Trade takes place in lotteries. Individuals face a standard budget constraint, while the incentive compatibility constraints are imposed on the production set of the intermediaries. This formalization encompasses moral hazard, as in Jerez, 2003 and Jerez, 2005, and private information economies. Equilibrium allocations are constrained efficient, but, contrary to what stated for example in Jerez (2005), the set of equilibrium allocations may be empty and the Second Welfare Theorem may fail. This happens for two reasons. First, constrained efficient allocations may violate the necessary and sufficient conditions of price supportability for the individuals. Second, even when constrained efficient allocation are price supportable, they may fail to be a profit maximizing choice of the firm at the individual supporting prices. To restore existence of an equilibrium the firm has to be restricted to supply allocations with support in the set of incentive compatible contracts.

► We study economies of asymmetric information with observable types. ► Trade takes place in lotteries. Firms supply incentive compatible lotteries. ► Equilibrium allocations are constrained efficient, but may not exist. ► The Second Welfare Theorem may fail. ► Equilibria exist if firms supply lotteries over incentive compatible contracts.