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The basics of Mechanism Design

Dan Grech Oct 15, 2007


Scott Jagow: This morning, three Americans won the Nobel Prize in Economics. These men came up with something called Mechanism Design Theory. Never heard of it? Me neither. But Dan Grech is gonna try to explain it to us.

Dan Grech: Markets don’t operate perfectly on their own. Sometimes, they need a little bit of help.

Mechanism Design Theory offers economists a toolbox to nudge markets toward a certain outcome. For example, it tells sellers which auction will get them the highest selling price. It tells insurers which policy provides the best coverage without inviting fraud. It tells trading partners how to best find a price that makes both sides happy.

Swedish economist Peter Englund is secretary of the Nobel Prize Committee in Economics:

Peter Englund: Mechanism design deals with very fundamental questions for economists. Namely, how should institutions be constructed to achieve certain economic goals, taking into account that individuals in society all have their own private information.

Englund says the applications for this theory touch nearly every corner of modern economics, from taxation to voting to corporate finance.

I’m Dan Grech for Marketplace.

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