The optimal mechanism for selling to a budget-constrained buyer (Q1581188)

The optimal method of selling to a buyer whose willingness to pay and ability to pay are private information is discussed. It is noted that the possibility of a binding budget constraint changes the optimal sales mechanism qualitatively. Contrary to many settings where a single price would be optimal in the absence of a binding budget constraint, the optimal mechanism in the situation considered involves a menu of contracts. But differently, there is nontrivial price discrimination. As such, the problem stated is not a special case of the existing models in which buyers are able to pay more than their reservation prices. Moreover, the seller may benefit from imposing a financial disclosure requirement, committing to a price schedule that declines over time, or providing financing. To illustrate the basic points of the method proposed two examples are given. The first shows that one cannot analyze the problem by defining the buyer's effective valuation as the minimum of his valuation and budget. The second example shows that a cash bond requirement can be used to extract additional revenue.