An economic analysis of the screening industry

Abstract

Utilizing a simple screening model, we explain how the provision of screening services alters equilibrium allocations of funds. For example, when screening services are available, banks tend to increase funding for risky projects and the equilibrium interest rate tends to fall. Indeed, the former is an increasing and the latter is a decreasing function of the extent of screening. These results accord well with our usual expectation. The proposed model, however, provides an unexpected result: It shows that having the screening industry run by a profit maximizing monopolist might be better than relying on many competing firms. This seemingly unusual result comes from the realization that, when many firms are competing, they produce essentially the same products over and over again, resulting in serious information duplications. A monopoly can easily avoid information duplications. However, it results in deadweight losses. Separating information production businesses from information selling businesses seems to be a better option. We show that when the former is handled by a single public entity and the latter is handled by many competing firms, we can have better outcomes. This arrangement solves the information duplication problem. More importantly, the resulting equilibrium configurations could be made identical to competitive equilibrium outcomes.