Tuesday, October 16, 2007

The Nobel Economics Prizes

They went to three guys (Leo Hurwicz, Eric Maskin Roger Myerson) who are credited with the theory of mechanism design. You get an idea about the possible meaning of this when I tell you that at least two of the three have doctorates not in economics but in mathematics. Yup, it's math stuff.

But it is also a way to address markets in a more realistic form than the one you may remember from an introductory economics course. Real world markets don't have that nice fairy godmother of perfect information. She is usually supposed to wave a wand so that all buyers and sellers know everything relevant about the product, its quality, possible substitutes and so on. Perfect information makes economic modeling easier but of course it is an unrealistic assumption in all but the most trivial marketplaces.

So what happens if, say, the sellers know a lot more about something relevant (such as the quality of the product they sell) than the buyers do? What kind of contracts would we expect to find in such markets and why? Would we anticipate some type of government regulation, to correct for the informational asymmetry? What institutions best achieve the goals of the participants in the exchange?

Mechanism design is one way of approaching questions like these.