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Working Papers, No. 2022-21, May 2022 Crossref
Optimal Procurement with Quality Concerns

(Revised September 2022)

Adverse selection in procurement arises when low-cost bidders are also low-quality suppliers. We propose a mechanism called LoLA which, under some conditions, is the best incentive-compatible mechanism for maximizing any combination of buyer’s and social surplus in the presence of adverse selection. The LoLA features a floor (or minimum) price, and a reserve (or maximum) price. Conveniently, the LoLA has a dominant strategy equilibrium that, under mild regularity conditions, is unique. We perform a counterfactual experiment on Italian government procurement auctions: we compute the gain that the government could have made, had it used the optimal mechanism (which happens to be a LoLA), relative to a first-price auction, which is the format the government actually used.

Working papers are not edited, and all opinions and errors are the responsibility of the author(s). The views expressed do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.


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