Abstract:
The Laffont–Tirole regulator observes the accounting costs of a firm but
she can neither observe its true cost-type nor its chosen effort level. This paper
considers a Laffont–Tirole regulator who could employ an expert to obtain better,
albeit not perfect, knowledge about the firm’s true cost type. Both the welfare gains
through superior allocations from better knowledge but also the knowledge
acquisition costs increase in the ‘marginal deadweight losses from taxes’ parameter
λ ≥ 0. We derive a closed-form expression of the overall welfare benefits from
knowledge acquisition as a function in λ. We characterize parameter conditions
such that knowledge acquisition could improve social welfare in dependence on
the value of λ. For this case we show that knowledge acquisition strictly increases
social welfare if and only if λ falls into the interval (λ*, ∞) whereby we present a
sharp characterization of the critical threshold-value λ* ≥ 0. In other words, information
acquisition through a regulator only increases welfare for economies
with comparatively high deadweight losses from taxation whereas welfare is
decreased whenever these deadweight losses are low.
