Speed read: Optimizing Social Institutions

In the mid 20th century, economists found themselves in need of a new theoretical framework with which to tackle the comparison of fundamentally different types of economic organization, such as capitalist and socialist institutions. Discussions between the likes of Oskar Lange and Friedrich von Hayek led to the development of the idea that economic institutions could be viewed as communication mechanisms, and set the stage for Leonid Hurwicz to formulate a general mathematical framework for analyzing institutions implementing collective decision making. His ‘Mechanism design theory’, first introduced in 1960, has developed into a powerful and widely-applied tool.

Whether one considers auctions, elections or the taxes we pay, our lives are governed by mechanisms which make collective decisions while attempting to take account of individual preferences. Such mechanisms are designed to deliver the greatest social good despite that fact that individual participants may act for their own gain, rather than for the general well-being of society. Studying such mechanisms is the goal of mechanism design theory, and mechanism design can be described as the art of producing institutions that align individual incentives with overall social goals.

Mechanism design theory is a branch of game theory (which psychologists refer to as the theory of social situations), and extends the application of game theory to ask about the consequence of applying different types of rules to a given problem. As a method of demonstrating which mechanism, out of all conceivable allocation mechanisms, gives the optimal result, mechanism design theory can be applied to problems as diverse as the auctioning of radio frequencies to mobile phone companies to the building of social welfare systems. Mechanism design theory lies at the heart of many organizations whose operation we now take for granted.

Eric Maskin and Roger Myerson were classmates at Harvard University, both graduating with doctorates in advanced mathematics in the same year. Their work has been instrumental in expanding the applicability of mechanism design theory to a wider variety of situations. At 90 years old, Leonid Hurwicz is the oldest person ever to be made a Laureate, the previous holder of that record being Raymond Davis Jr., who was almost 88 when he became a Physics Laureate in 2002.

By Adam Smith, Editor-in-Chief, Nobelprize.org

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