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Watching video "Mechanism Design Theory: How to Implement Social Goals"

Lecturer: Maskin Eric
Caught on video: Kuzminov Yaroslav Polterovich Victor
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Public Lecture at HSE

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Slide 1: Mechanism Design Theory: How to Implement Social Goals   0:5:41  
  • E. Maskin
  • Institute for Advanced Study
Slide 2: "Theory of Mechanism Design –"   0:12:54  
  • Theory of Mechanism Design –
  • “engineering” part of economic theory
  • much of economic theory devoted to:
    • understanding existing economic institutions
    • explaining/predicting outcomes that institutions generate
    • positive, predictive
  • mechanism design – reverses the direction
    • begins by identifying desired outcomes (goals)
    • asks whether institutions (mechanisms) could be designed to achieve goals
    • if so, what forms would institutions take?
    • normative, prescriptive - - i.e., part of welfare economics
Slide 3: "For example"   0:15:25  
  • For example, suppose
  • mother wants to divide cake between 2 children, Alice and Bob
  • goal: divide so that each child is happy with his/her portion
    • Bob thinks he has got at least half
    • Alice thinks she has got at least half
    • call this fair division
  • If mother knows that the kids see the cake in same way she does, simple solution:
    • she divides equally (in her view)
    • gives each kid a portion
Slide 4: "But what if"   0:18:6  
  • But what if, say, Bob sees cake differently from mother?
    • she thinks she’s divided it equally
    • but he thinks piece he’s received is smaller than Alice’s
  • difficulty: mother wants to achieve fair division
    • but doesn’t have enough information to do this on her own
    • in effect, doesn’t know which division is fair
Slide 5: "Can she design a mechanism..."   0:19:13  
  • Can she design a mechanism (procedure) for which outcome will be a fair division?
  • (even though she doesn’t know what is fair herself ?)
  • Age-old problem
    • Lot and Abraham dividing grazing land
Slide 6: "Age-old solution"   0:20:13  
  • Age-old solution:
    • have Bob divide the cake in two
    • have Alice choose one of the pieces
  • Why does this work?
  • Bob will divide so that pieces are equal in his eyes
    • if one of the pieces were bigger, then Alice would take that one
  • So whichever piece Alice takes, Bob will be happy with other
  • And Alice will be happy with her own choice because if she thinks pieces unequal, can take bigger one
Slide 7: "Example illustrates key features of..."   0:22:5  
  • Example illustrates key features of mechanism design:
  • mechanism designer herself doesn’t know in advance what outcomes are optimal
  • so must proceed indirectly through a mechanism
    • have participants themselves generate information needed to identify optimal outcome
  • complication: participants don’t care about mechanism designer’s goals
    • have their own objectives
  • so mechanism must be incentive compatible
    • must reconcile social and individual goals
Slide 8: "Second Example"   0:24:23  
  • Second Example:
  • Suppose government wants to sell right (license) to transmit on band of radio frequencies
    • (real-life issue for many governments, including in U.S.)
    • several telecommunication companies interested in license
    • goal of government: to put transmitting license in hands of company that values it most (“efficient” outcome)
    • but government doesn’t know how much each company values it (so doesn’t know best outcome)
Slide 9: "Government could ask each company..."   0:27:14  
  • Government could ask each company how much it values license
    • but if company thinks its chances of getting license go up when it states higher value, has incentive to exaggerate value
    • so no guarantee of identifying company that values it most
Slide 10: "government could have"   0:28:11  
  • government could have
    • each company make a bid for license
    • high bidder wins license
    • winner pays bid
  • but this mechanism won’t work either
    • companies have incentive to understate
  • suppose license worth $10m to Telemax, then
    • if Telemax bids $10m and wins, gets
    • $10m − $10m 0
  • so Telemax will bid less than $10m
  • but if all bidders are understating, no guarantee that winner will be company that values license most
Slide 11: "Solution"   0:30:51  
  • Solution:
    • every company makes bid for license
    • winner is high bidder
    • winner pays second-highest bid
      • so if 3 bidders and bids are
      • $10m, $8m, and $5m,
      • winner is company that bids $10m
      • but pays only $8m
    • Now company has no incentive to understate
      • doesn’t pay bid anyway
      • if understates, may lose license
    • Has no incentive to overstate
      • If bids $12m, will now win if other company bids $11m
      • But overpays
    • So best to bid exactly what license worth
    • And winner will be company that values license most
Slide 12: "Final Example"   0:36:25  
  • Final Example
  • Consider society with
  • 2 consumers of energy – Alice and Bob
  • Energy authority – must choose public energy source
    • gas
    • oil
    • nuclear power
    • coal
Slide 13: "Two states of world"   0:37:51  
  • Two states of world
  • state 1    consumers weight future lightly (future relatively unimportant)
  • state 2  consumers weight future heavily (future relatively important)
  • Alice – cares mainly about convenience
  • In state 1:   favors gas over oil, oil over coal, and coal over nuclear
  • In state 2:   favors nuclear over gas, gas over coal, and coal over oil
  •           − technical advances expected to make gas, coal, and especially              nuclear easier to use in future compared with oil
  • Bob – cares more about safety
  • In state 1:   favors nuclear over oil, oil over coal, and coal over gas
  • In state 2:   favors oil over gas, gas over coal, and coal over nuclear
  •           − disposal of nuclear waste will loom large
  •           − gas will become safer
Slide 14: "energy authority"   0:41:26  
  • energy authority
    • wants source that makes good compromise between consumers’ views
    • so, oil is social optimum in state 1
    • gas is social optimum in state 2
  • but suppose authority does not know state
    • then doesn’t know whether oil or gas better
Slide 15: "authority could ask Alice or..."   0:43:47  
  • authority could ask Alice or Bob about state
    • but Alice has incentive to say “state 2” regardless of truth
    • always prefers gas to oil
    • gas optimal in state 2
    • Bob always has incentive to say “state 1”
    • always prefers oil to gas
    • oil optimal state 1
    • So, simply asking consumers to reveal actual state too naive a mechanism
Slide 16: "Authority can have consumers participate..."   0:45:30  
  • Authority can have consumers participate in the mechanism given by table
    • Alice – can choose top row or bottom row
    • Bob – can choose left column or right column
    • outcomes given by table entries
    • If state 1 holds
    • Alice will prefer top row if Bob plays left column
    • Bob will always prefer left column
    • so (Alice plays top, Bob plays left) is Nash equilibrium
    •    neither participant has incentive to change unilaterally to another strategy
    • In fact, it is unique Nash equilibrium
    • −  so good prediction of what Alice and Bob will do
Slide 17: "So"   0:49:24  
    • So, in state 1:
      • expect that
      •      Alice will play top strategy
      •           Bob will play left strategy
      • outcome is oil
      • oil is social optimum
Slide 18: "Similarly"   0:49:40  
    • Similarly, in state 2:
      • expect that
      •      Alice will play bottom strategy
      •           Bob will play right strategy
      • outcome is gas
      • gas is social optimum
Slide 19: "Thus"   0:50:17  
    • Thus, in either state, mechanism achieves social optimum, even though
    • −  mechanism designer doesn’t know the state herself
    • −  Alice and Bob interested in own ends (not social goal)
    • We say that mechanism implements the designer’s goals (oil in state 1, gas in state 2)
Slide 20: "Have shown you mechanisms in..."   0:50:39  
  • Have shown you mechanisms in the cake, telecommunication, and energy examples
  • But analysis may seem a bit ad hoc
  • Examples prompt questions:
    • is there a general way of determining whether or not a given goal is implementable?
    • if it is implementable, can we find a mechanism that implements it?
  • Answer:  yes to both questions
    • see Maskin “Nash Equilibrium and Welfare Optimality,” 1977
Slide 21: "Have looked at 3 applications..."   0:53:3  
  • Have looked at 3 applications of mechanism design theory
  • Many other potential applications
  • International treaty on greenhouse gas emissions
  • Policies to prevent financial crises
  • Design of presidential elections

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