Three US economists who established and developed theories governing how trade between two individuals or companies takes place and how it can be optimised have won the Nobel prize for economics.
The Royal Swedish Acadamy of Sciences announced on Monday that Leonid Hurwicz, Eric Maskin and Roger Myerson would share the 2007 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for “for having laid the foundations of mechanism design”.
Mechanism design theory was initiated by Professor Hurwicz in the early 1960s and developed separately by professors Maskin and Myerson in the 1970s and 1980s.
The economists will share a prize of SKr10m ($1.57m).
One of the basic problems in economics is that markets are remarkably efficient, but they work best only under rather extreme assumptions. If information held by buyers or sellers is private - for example how much someone is really willing to pay for something - trade can break down.
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.
Professor Hurwicz, Russian-born but a US citizen and now 90, introduced to economics the important notion of “incentive compatibility” in 1972 which proved central to later developments, both theoretical and practical.
One of the most important practical areas it has been used is in economic regulation of industry, where companies have huge incentives not to reveal their private costs or information.
The theoretical work has led to more effective regulatory concepts, such as the design of auctions that give the parties an incentive to reveal their private information, enabling everyone to benefit. Professor Myerson’s 1981 paper “Optimal auction design” was a seminal work in this field.
Similarly, the regulation of subscription television has benefited from the theoretical work of mechanism design in specifying when the bundling of channels in a packaged is in consumers’ interests.
The theory provides economists with a general tool-kit to analyse different market structures and has wider applications in social science with its use in helping to design voting systems.
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.
