Why They Won the Nobel for Economics

The Nobel Prize in economics goes to Americans Leonid Hurwicz, Eric Maskin and Roger Myerson for their work on Mechanism Design Theory, an offshoot of game theory which is used to make imperfect markets work more efficiently.

(Technically, it’s the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. It was not mentioned in Alfred Nobel’s will, and has only been awarded since 1969.)

Hurwicz, 90, a professor emeritus at the University of Minnesota, is the oldest Nobel Prize winner, ever. His work on the theory began in the 1960s, when his baby-boom generation co-winners were barely in their teens. Myerson is from the University of Chicago, which brings its Nobel-in-economics total to 24, more than a third of all winners. Maskin is a professor of social science at the Institute of Advanced Study and a “Visiting Lecturer in Economics with the Rank of Professor” at Princeton University.

It’s beyond my capabilities to explain the winning theory. However, here is a good illustration of the problem it is designed to address, from blogger (and econ prof) Alex Tabarrok, who writes at Marginal Revolution.

Suppose that you are selling a rare painting for which you want to raise the maximum revenue. There are two potential buyers, Tyler, who values the painting at $100,000, and Alex who values it at $20,000. The problem would be simple if you knew this information – you would then set the price at $99,999 and Tyler would buy maximizing your revenue. But how much Tyler and Alex value the painting is their own private information. How then should sell the painting?

One possibility that springs quickly to mind is an auction. In a standard English open-cry auction Alex and Tyler will bid for the painting and the bids will keep rising until Alex is forced to drop out at $20,001. Thus the auction earns you $20,001. Not bad but is this the maximum revenue possible? Remember that Tyler values the painting at $100,000 so you could be leaving a lot of money on the table.

What else can you do?

Now, go read the post if you want to find out, and good luck.

Very helpfully, at the end of his post, Tabarrok lists some of real-world applications of the theory, such as…

How to raise taxes, regulate a monopolist, fund a public good…, allocate organs, assign interns to hospitals, split common costs, allocate electricity across a grid – all can be thought of as mechanism design problems. The tools that Hurwicz, Maskin and Myerson developed…(help) us to design, at least in principle, the best solutions to all of these problems.

For another explanation, go here. Or here. And here is a post about an economist who believes mechanism design theory is “the only coherent approach to figuring out what the economic role of banks or other financial intermediaries is.”

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