Monopolistic group design with peer effects

In a range of settings, private firms manage peer effects by sorting agents into different groups, be they schools, communities, or product categories. This paper considers such a firm, which controls group entry by setting a series of anonymous prices. We show that private provision systematically leads to two distortions relative to the efficient solution: first, agents are segregated too finely; second, too many agents are excluded from all groups. We demonstrate that these distortions are a consequence of anonymous pricing and do not depend upon the nature of the peer effects. This general approach also allows us to assess the way the ‘returns to scale’ of peer technology and the cost of group formation affect the optimal group structure. K. Mechanism design, peer effects, public goods, network effects. JEL . D82, H40, L12.