Screening (economics)

Fundamentally, the strategy involved with screening comprises the “screener” (the agent with less information) attempting to gain further insight or knowledge into private information that the other economic agent possesses which is initially unknown to the screener before the transaction takes place.

The exact type of information intended to be revealed by the screener ranges widely; the actual screening process implemented depends on the nature of the transaction taking place.

Screening techniques are employed within the labour market during the hiring and recruitment stage of a job application process.

In general, parties providing insurance perform such activities to reveal the overall risk level of a customer, and as such, the likelihood that they will file for a claim.

When in possession of this information, the insuring party can ensure a suitable form of cover (i.e. commensurate with the customer’s risk level) is provided.

Rothschild and Stiglitz found that individuals (uninformed party) are able to initiate action by extracting information through screening in order to better position themselves in the market.

Moreover, this allowed insurance companies to create policy contracts for higher deductibles in exchange for lower premiums.

Therefore, insurance companies need to ensure that further information is gathered prior to concluding what category individuals suit.

[13] An agent has private information about his type (e.g., his costs or his valuation of a good) before the principal makes a contract offer.

Typically, the best type will trade the same amount as in the first-best benchmark solution (which would be attained under complete information), a property known as "no distortion at the top".

For example, it has been shown that, in the context of patent licensing, optimal screening contracts may actually yield too much trade compared to the first-best solution.