National Conference

On
Relevance of Mechanism Design and
Game Theory in
Modern Economic Analysis
KSHEC, Bangalore
10-01-2013

A Review Paper by
DR V BASIL HANS

Associate Professor and Head, Dept of

Economics, St Aloysius Evening College,
Mangalore 575 003. Karnataka State, INDIA.
Email: vbasilhans@yahoo.com

Introduction
This paper is an attempt to revisit the theory
of mechanism design as an analytical tool in
economic theory in general and managerial
economics in particular
Economics econometrics: metrical
economics
Two motives: understanding how the world
works; & how to solve the problems of this
world

Introduction contd
Economic environment is designed too
Actors designers design institutions by actions
based on information and induced by
incentives
Mechanism design: tool to model, analyse, and
solve decentralised design problems
Importance of mechanism design in synthesising
incentives, institutions and information, e.g.
virtual designing, cybernomics

Mechanism Design Theory the essence

Mechanism design sets the stage for playing
(planning) social choice, for instance
Mechanism design is sometimes called reverse
game theory
Game involves auctions, signalling, selections,
computations, configurations etc. Their game is
the problem of aggregating the announced
preferences of multiple agents into a collective
decision when the agents exhibit strategic
behaviour

Contd
The outcome of the game is the final decision
(design)
Thus, game is defined as activity between two or
more persons involving activities by each person
according to a set rules, at the end of which each
person gets some benefit or suffers loss
Rules of the game = strategies at play indicating
operational effectiveness, mostly in response to
competition.

Contd
Actors (players) moves in the arena are steps
for progress along the production frontier
through progressive investments, creation of
jobs, market penetration etc
Maximisation of gain/minimisation of pain is
the objective function. The outcome could be
either a zero sum game or a pay-off matrix.
Falling below optimality reflects failure in the
mini-max objectives of the game

Mechanism Theory a Major Breakthrough in Modern

Economic Analysis and Policy-making

It revolutionalised the way economists think

about optimal institutions and regulation when
governments don't know everything.
Leonid Hurwicz (1960s): How should a planner
reach a decision when the quality of the decision
relies on information spread among a number of
people? Any solution should take into account
the incentives of self-interested agents, i.e., the
people on whose information the decision relies
must find it in their interest to reveal that
information

Contd
Three key inputs: 1. a collective decision
problem (team work), 2. a measure of quality
to evaluate the work (welfare/efficiency etc)
to arrive at equilibrium decision, and 3. a
description of the resources
Playing a game means to send messages (e.
bid) which are the function of information
Earlier works: Sraffa, John Muth, Robert Lucas
Jr, Robinstein, Kalai and Smorodinsky.

Information and Mechanism Design

(Co-related) Information is a cornerstone in
mechanism design theory, e.g. in models of
asymmetric information, possession of private
information leads to rents for the possessors
The basic issue in mechanism design is how to
truthfully elicit private and decentralised
information in order to achieve some objective(s)
private or social
Revealing information needs incentives and Lack
of information can lead to incentive constraints!

Contd
If additional information has little impact on the
eventual decision, there is no point to acquiring
it. One of the perspectives of information
applications is that the participants' information
depends on the mechanism chosen. An
auctioneer may have control over pieces of
evidence that determine the bidders' valuation
for the object on sale. Whether it is in the
auctioneer's best interest to disclose this
information depends on the properties of the
auction to follow

Incentives and Mechanism Design

Mechanisms can be thought of as institutions
that co-ordinate societies on particular collective
choices. Maskin proved that a social choice rule
can be implemented in Nash equilibrium if the
economy contained three or more agents, and
the rule satisfied,
no-veto power" and
monotonicity"
A good mechanism ought to provide incentives
for producing the relevant information, say ex
post incentive compatibility (e.g. truthtelling
exercise), socially efficient information etc

Contd
Ex post equilibrium is increasingly studied in game
theory and is often used in mechanism design as a
more robust solution concept by Dasgupta and Maskin
(2000 article on efficient auctions)
Our main contention is that the preference diversity
may increase the individual members' incentives for
acquiring information.
For any given mechanism, there may exist a type space
which exposes weaknesses in the incentive constraints
and leads to an inferior expected revenue result

Institutions and Mechanism Design

Much theoretical work, focuses on existing economic
institutions. The theorist wants to explain or forecast the
economic or social outcomes that these institutions
generate
But in mechanism design theory the direction of inquiry
is reversed. We begin by identifying our desired outcome
or social goal. We then ask whether or not an
appropriate institution (mechanism) could be designed
to attain that goal. If the answer is yes, then we want to
know what form that mechanism might take. Thus, a
design becomes a social exercise or an action with
social goals

Contd
Mechanism design theory helps us understand institutions
ranging from simple trading rules to political constitutions
We can understand institutions as the solution to a well
dened planners problem of achieving some objective or
maximising some utility function subject to incentive
constraints
Some of the general questions raised by the theorist are
What is the performance of existing institutions if the domain
of preferences broadens?
Are there (novel) institutions that induce good performance in
expanded domains?

Contd
Examples:
Mechanism design shows that public goods can be
voluntarily provided.
In other situations, mechanism design can make
government more effective, but it will do so by
making
government
more
"market-like."
Contracting-out of government services like solid
waste management, prisons, roads etc, can be
carried out even farther if contracts are more
carefully designed.

Conclusion
We have shown how the theory of mechanism design is the
engineering side of economic theory, and how incentives,
information and institutions are correlated in the framework or
field of mechanism design
Mechanism design is the foundation for the sophisticated auctions
that have been used to sell off broadcast spectrum
In a sense, mechanism design is to markets what genetic algorithms
are to life. sub-fields like elections and voting, budgeting, delivery
of public goods (e.g. defence, education, healthcare etc) all have
connections with mechanism design theory on a common platform
of Outcomes-Goals-Mechanisms
On electing political representatives: recent work by Partha
Dasgupta and Eric Maskin: On the Robustness of Majority Rule.

Contd
Informed choices and responsibilities are essential for fair play
One of the limitations of our paper is that we have not dealt
with implementation aspects of the design theory in detail.
Implementation itself is a function of many messages and
choices/outcomes, some priori. An interesting problem for
future research is the characterisation of how many
supplemental messages are required for different classes of
problems.
economics is still remains a science and an art. Engineering
science has brought to its fold social choices and handed
them over to econometrics for treatment before handing over
back to parent, economics. A fine playing (designing),
indeed!

THANKS

TO the Organizers of this Conference

All the other speakers
Audience
Will there be new designs? Of course there
will be!