Peter Cramton emailed a bunch of us today asking us to sign a comment he and others are submitting to a House Committee.  There are many issues but one is related to an odd pricing rule proposed for buying equipment for Medicare.

Suppose Medicare needs x machines and wants to save money.  They can run a simple procurement auction (or some variant) as follows: Suppliers submit bids and the lowest x bids are accepted and all are paid the highest accepted bid.  This is similar to a market mechanism that spits out a market clearing price that all suppliers receive.  Just like the market mechanism, all but the highest cost supplier get surplus at the market-clearing price.  Is there some way to leave the suppliers with less rent and for Medicare to save more money?  Unless Medicare knows the costs of production of the suppliers, the answer is basically “No”, under reasonable assumptions.  Any mechanism has to leave low cost suppliers with information rent and the minimum rent is left by the market-clearing mechanism.

But it seems that does not stop Medicare from trying!  They are proposing a median pricing rule where the lowest x bidders are chosen but are paid the median of the x winning bids.  This means the top 50% of bidders are not paid their submitted bids. This leads to many pathologies as the authors point out in their comment.  First, the top 50% may simply refuse to supply and withdraw their bids (this is allowed under the present auction rules).  Then Medicare will be left with less equipment than it needs.  Or the suppliers may make a loss if they are forced to supply for one reason or another.  This is not good for the long term financial health of the suppliers.  Or they may game and shade their bid etc. etc.

Check out the comment for more detail.  Peter is providing a public good and testifies in front of the House Committee on September 27.  We’ll see what happens.  If the median pricing rule stays in place despite Peter’s best efforts, expect to see (many!) papers working out equilibria of the procurement auction under that rule!