Incentive Compatibility

Incentive compatibility (IC) is the constraint, in a Screening menu, that each consumer type weakly prefers the contract designed for its type over any other contract in the menu. With two types $L$ and $H$ and contracts $(p_L, q_L)$ and $(p_H, q_H)$, the IC pair is

The binding constraint is typically the high type's IC — the high type is the one most tempted to mimic the low type.

When to use

Always check IC after writing a screening menu — without it the menu collapses to pooling. In the lecture's a-vs-b trade-off, the high type's IC is what forces the firm to leave Information Rent on the table; the low type's IC is typically slack at the optimum. Combined with individual rationality (each type's outside option), IC pins down the optimal menu.