Optimal allocation of an indivisible good

Abstract

In this paper, we consider the problem of allocating an indivisible good efficiently between two agents with monetary transfers. We focus on allocation mechanisms that are dominant-strategy incentive compatible when agents' types are private information. Inefficiency of an allocation mechanism may come from two sources: misallocation of the indivisible good and an imbalanced budget. Unfortunately, as Green and Laffont (1979) demonstrate, no allocation mechanism can always overcome both kinds of inefficiency. We identify allocation mechanisms that maximize the expected total utilities of agents, and characterize optimal mechanisms for a large class of agents' type distributions. For strongly regular type distributions, we show that the optimal mechanisms must be budget-balanced: they are either fixed-price mechanisms or option mechanisms. The result may not hold for other type distributions. For certain type distributions, we show that optimal mechanisms are hybrids of Vickrey–Clarke–Groves mechanisms and budget-balanced mechanisms.