Necessary Roughness

FT.com, AFP, and others report that three U.S. economists have won the Nobel Prize for economics. They got the award “for having laid the foundations of mechanism design.”

I’ve not had a chance to read any of their work yet, but the FT.com article leads to some questions:

One example of the sort of problems mechanism design theory can analyse occurs regularly, when buyers and sellers lie about their true motives and economics.

A company might say it is only willing to provide a service for $200 when, in fact it will make a profit if it charged $150. Another might say it is only willing to buy at $100 when it is really willing to pay up to $170.

In this example, trade is certainly possible between the range of $150 and $170, but might not happen because both the buyer and the seller have an incentive to misrepresent their true positions.

Economics is always about tradeoffs. A company that can supply something at $200 might be able to supply it at $150 if it can cut corners somewhere. A consumer might pay more for an item that lasts longer, has better on-board software, etc.

Suppose a buyer and seller lie about what they are willing to pay and thus can’t come into an agreement. They both lose, because no transaction is conducted. The supplier can’t meet his payroll, and the buyer doesn’t have what he wants. A supplier who prices his item too high without justifying its value may lose work to a competitor who can do the job more cheaply. A low-ball buyer might lose to a competitor wanting to purchase a limited supply at a higher price. There really isn’t a place for a lie.

Move into a single-payer (like Hillary’s health care) or single-supplier (like driver’s licenses) situation, and there is possibility for people to lie and still benefit. A single-payer will force companies to either do business with them or get out of business altogether, reducing availability. A single-supplier (monopoly) situation can raise prices to their heart’s content until people seek completely different alternatives. I would not be surprised if the mechanism design-game theory work applied in this situation.

Given the ties between the Nobel Peace Prize and environmentalism, the final paragraph of the FT.com article is intriguing:

One of its uses for the future will come in environmental theory and policy, areas in which professor Maskin has been active this decade, where the mechanism of and domestic and international regulation will be crucial for its success in preventing global warming and other environmental degradation.

The chemistry prize was given to Gerhard Ertl of Germany for a process that has implications on the behavior of the ozone layer. That means three of the six Nobel Prizes have connections to global warming. I won’t say it’s bias, but the coincidence is interesting.