Presentation Speech by Professor Jörgen Weibull, Member of the Royal Swedish Academy of Sciences, Chairman of the Economics Prize Committee, 10 December 2007.
|Professor Jörgen Weibull delivering the Presentation Speech for the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2007 at the Stockholm Concert Hall.
Copyright © The Nobel Foundation 2007
Photo: Hans Mehlin
Your Majesties, Your Royal Highnesses, Honoured Laureates, Ladies and Gentlemen,
This year’s Economics Prize is about design. Let me explain.
Philosophers and social scientists have long realized that it is not necessary that all citizens strive to enhance social welfare for the outcome of their joint actions to be nevertheless good for society at large. Adam Smith’s classical metaphor of the “invisible hand” suggests precisely this: how markets under ideal conditions lead to an efficient allocation of resources even when all agents are motivated by their self-interest.
However, in practice conditions are rarely ideal. Competition is never completely free, consumer information about goods and services is often imperfect and the consumption and production of households and firms may have positive or negative side-effects on others and on the environment. Moreover, many transactions do not even take place in open markets but under a host of other institutional arrangements.
In markets, it sometimes happens that buyers and sellers fail to agree about the price. Thus, not all mutually beneficial transactions are carried out. Projects of common interest are sometimes not realized because the parties involved cannot agree on how costs should be shared. Social insurance systems are often criticized both for providing too little protection and for inviting abuse. These situations have one problem in common: the parties involved have self-interest in withholding relevant information. Sellers can maintain that their costs are high in order to receive a high price. Those who benefit from a project of common interest may, in order to minimize their contribution, claim that they do not benefit very much. Those who are covered by social security may claim that they are entitled to support also when this is not the case.
How well do different institutional arrangements or allocation mechanisms work, when due account is taken of individual agents’ incentives and private information? How can some of the market forms and transaction procedures that we observe be explained? What is the best mechanism to use in order to obtain a given goal, such as social welfare, efficiency, fair distribution or a good environment? Are governmental regulations called for, and, if so, how are they best designed?
Thus, this year’s prize concerns design: the design of institutional arrangements, rules and procedures for economic activity and collective decision-making.
Mechanism design theory provides general methods for the analysis and development of mechanisms for resource allocation. This analysis is carried out in three steps. First, one makes a prediction of the behaviour that is expected under given rules. Here, game theory comes to use. Thereafter, one evaluates, according to the given goal, the resource allocations – such as consumption, production and environmental stress – that result. Finally, one looks for the mechanism, with due regard to its behavioural implications, that best meets the goal. The last step is the hardest. Here, the so-called revelation principle comes into use, a principle that was discovered by several researchers in the 1970s; according to this principle it suffices to look for the best possible direct mechanism that is compatible with individual incentives –a subclass of mechanisms that permits mathematical analysis. The user of a mechanism also desires that this not only can lead to the desired outcome but in fact will lead to such an outcome. Expressed in more technical jargon, the mechanism should not permit suboptimal equilibria along with the optimal ones.
The theory of mechanism design currently plays a major role in many areas of economics and in parts of political science, and has led to many fruitful applications. Its domain of application has expanded in recent years, due to globalization and growing internet trade, phenomena that impose new demands on old institutions.
Dear Drs. Hurwicz, Maskin and Myerson: You have laid the foundation of the theory of mechanism design, thereby providing a systematic and rigorous approach to central questions in economics. This has enabled economists not only to study the performance of existing economic institutions but also to suggest how these can be improved, and to identify the theoretical limits to what can be achieved when we take into account the constraints that emanate from individuals’ incentives and private information.
Dr Hurwicz: you pioneered this whole field and introduced some of the key perspectives and concepts. In particular, you suggested that economic institutions be conceived of as information systems within which agents send messages, and where these messages together determine an allocation of the available resources. In this context you also introduced the key notion of incentive compatibility.
Dr Maskin: you did pioneering work on implementation theory, that part of the theory of mechanism design which deals with the problem of the potential co-existence of inferior equilibria along with the desired ones. You have also made numerous other important contributions, both to the pure theory of mechanism design and to its application to areas such as auctions, monopoly and social choice.
Dr Myerson: you have been the leader in applying mechanism design theory to games of incomplete information, that is, situations in which different agents do not know each other’ s goals, costs or actions. This has helped us better understand optimal auctions, bargaining and regulation. You have also established the great generality and usefulness of the revelation principle.
It is an honour and a privilege to convey to you, on behalf of the Royal Swedish Academy of Sciences, our warmest congratulations. I now ask you to receive your Prizes from His Majesty the King.
Their work and discoveries range from the Earth’s climate and our sense of touch to efforts to safeguard freedom of expression.
See them all presented here.