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Economic Quarterly

Fourth Quarter 2014

Optimal Institutions in Economies with Private Information: Exclusive Contracts, Taxes, and Bankruptcy Law

Borys Grochulski and Yuzhe Zhang

In economies with private information, it is typically optimal to prohibit or otherwise discourage a subset of trades that individual agents want to enter. Economists often refer to such optimal distortions as wedges. In this article, we use a simple private-information Mirrleesian economy to, first, show examples of these wedges and, second, discuss institutions that may be used to implement them in practice. We discuss and compare three such institutions: exclusive contracts, taxes, and bankruptcy law. Our analysis underscores the multiplicity of possible implementations and, therefore, the difficulty in using private information as a basis for normative analysis of any one such institution. Yet, the differences in the degree of decentralization and empirical relevance make implementation exercises considered here useful in thinking about the implications of private information for economic outcomes and observed institutions.

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