MECHANISM DESIGN

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The Economist presents in its article from October 15
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a theory which has a real
impact on the world, so called mechanism design .With this theory, Leonid Hrwic!, Eric
"as#in and $o%er "yerson won the &obel 'ri!e. The &obel committee didn(t follow the lead
of the peace)pri!e, they decided to honor a sb*ect that sonds so dismal becase it is a h%ely
important area of economics and parts of political science. This theory allows s to discern
the sitations when the mar#ets cler# well by the sitations when they cler# wron%, or how to
arran%e or economic interactions so that, when e+eryone beha+es in a self)interested manner,
the reslt is somethin% we all li#e.
They shaped a branch of economics that has had a broad impact, both in academia ,in
sb*ects sch as incenti+e theory, %ame theory, and the political science of instittions- and in
the real world. Each of them had an important role, for e.ample, "r. Hrwic! came with a bi%
idea, called /incenti+e compatibility becase he obser+ed that there was a lac# of incenti+e
for people to share their information with the %o+ernment trthflly. The winners of the &obel
'ri!e are all mathematicians and they deploy some +ery ele%ant mathematics methods
especially "r. Hrwic!. 0lso, "r. "yerson contribtes to mechanism desi%n with his wor# on
the /re+elation principle, a mathematical method that simplifies calclation of the most
efficient rles of the %ame for %ettin% people to re+eal their pri+ate information trthflly. "r.
"as#in came with the /implementation theory.
Mechanism design - invisible hand
"echanism desi%n theory allows s to distin%ish sitations in which mar#ets wor#
well from those in which they do not. 1t has helped economists identify efficient tradin%
mechanisms, re%lation schemes and +otin% procedres. "echanism desi%n is a +ery %eneral
way of thin#in% abot instittions. 0n instittion or mechanism ta#es as inpt 2messa%es2 or
2si%nals2 from a%ents and it responds with an otcome. The idea of mechanism desi%n is to
create instittions that prodce a desirable otcome while respectin% the fact that a%ents ha+e
pri+ate information and are self)interested. 1t trns ot that desi%nin% mechanisms that wor#
well while respectin% information and self)interest constraints is +ery difficlt.
3or illstrate this theory we can %i+e an e.ample4 we sppose we ha+e two children
who are thin#in% of how to di+ide a pie. We need a method to di+ide the pie fairly. 'arents
will already #now one answer5one child cts and the second child chooses. The second child
will choose the lar%er half which %i+es the first child the incenti+e to ct as e+enly as
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possible. The first)ct, second)choose soltion is a simple e.ample of an incenti+e)compatible
mechanism. Leonid Hrwic!, Eric "as#in, and $o%er "yerson recei+ed the &obel 'ri!e in
economics, consists in 61.5m, for their stdy of incenti+e)compatible mechanisms or, more
informally, 2mechanism desi%n2. "echanism desi%n is the art and science of desi%nin% rles
of a %ame to achie+e a specific otcome, e+en tho%h each participant may be self)interested.
3rederic 7astiat saw the self)interest moti+e as central to hman natre. 1t mst be clearly
nderstood that this word is sed here to desi%nate a ni+ersal, incontestable fact, resltin%
from the natre of man, and not an ad+erse *d%ment, as wold be the word selfishness. One
of 7astiat8s most important contribtions to the field of economics was his ad+ice admonition
to the effect that %ood economic decisions can only be made by ta#in% into accont the 2fll
pictre.2 That is, economic trths shold be arri+ed at by obser+in% not only the immediate
conse9ences 5 that is, benefits or liabilities 5 of an economic decision, bt also by
e.aminin% the lon%)term conse9ences. 0dditionally, one mst e.amine the decision8s effect
not only on a sin%le %rop of people ,say candlema#ers- or a sin%le indstry ,say candles-, bt
on all people and all indstries in the society as a whole. 0s 7astiat famosly pt it, an
economist mst ta#e into accont both 2What is :een and What is &ot :een.2 7astiat8s 2rle2
was later e.ponded and de+eloped by Henry Ha!litt in his wor# Economics in One Lesson,
in which Ha!litt borrowed 7astiat8s trenchant 27ro#en Window 3allacy2 and went on to
demonstrate how it applies to a wide +ariety of economic falsehoods.
&owadays, somethin% mch more %eneral is meant by the e.pression 2in+isible hand2.
0n in+isible hand process is one in which the otcome to be e.plained is prodced in a
decentrali!ed way, with no e.plicit a%reements between the actin% a%ents. The second
essential component is that the process is not intentional. The a%ents8 aims are not
coordinated, nor identical with the actal otcome, which is a byprodct of those aims. The
process shold wor# e+en withot the a%ents ha+in% any #nowled%e of it. This is why the
process is called in+isible.
0dam :mith assmed that consmers choose for the lowest price, and that
entrepreners choose for the hi%hest rate of profit. He asserted that by ths ma#in% their
e.cess or insfficient demand #nown thro%h mar#et prices, consmers 2directed2
entrepreners8 in+estment money to the most profitable indstry. $emember that this is the
indstry prodcin% the %oods most hi%hly +aled by consmers, so in %eneral economic well)
bein% is increased.
The common points between mechanism desi%n an the in+isible hand are represented
by 4 mar#et de+elopment and it tries to %ide the fnds to the most profitable indstry.
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Pareto efficiency and incentive efficiency
A central concept in economics is 'areto efficiency. 0 sitation is said to be 'areto
efficient if there is no way to rearran%e thin%s to ma#e at least one person better off withot
ma#in% anyone worse off. The term is named for an 1talian economist, <ilfredo 'areto.
What ma#es 'areto efficiency important is that almost e+eryone wold a%ree that
society shold a+oid sitations that are not 'areto efficient. That is, when somethin% cold be
done to ma#e at least one person better off withot hrtin% anyone, most people wold a%ree
we shold do it.
Economists often describe inefficient sitations as 2lea+in% money on the %rond.2 To
see why, ima%ine that someone wal#in% alon% a deserted beach finds a 6;0 bill on the sand. 1f
she pic#s it p, she8s better off and no one else is worse off. Lea+in% the bill on the sand to
wash ot to sea wold be silly. =o mi%ht be tempted to reply 2Wait, isn8t the ori%inal owner
of the bill worse off>2 The answer is 2&o2 becase it8s important to distin%ish between two
different e+ents4 ,1- the ori%inal owner losin% the bill, and ,;- the other person findin% it. The
ori%inal owner definitely became worse off when he lost the bill. Howe+er, once the bill is
%one, he8ll be the same whether someone pic#s it p or it washes ot to sea.
'areto efficiency is important in comparin% economic otcomes. 1t8s a wea# standard
becase there may be many efficient sitations and the 'areto test doesn8t tell s how to
choose between them. 1ma%ine that two people are wal#in% to%ether alon% the beach when
they find the bill. 0ll of the followin% are efficient4 one person pic#s it p and #eeps it? the
other person pic#s it p and #eeps it? one person pic#s it p and %i+es 610 to the other? and so
on. Who %ains from findin% the bill is 9ite different in those scenarios bt they all a+oid the
inefficiency of lea+in% it sittin% on the beach.
"ch of economics is concerned with identifyin% inefficient sitations and desi%nin%
policies and instittions that will promote efficiency and redce inefficiency. 0 policy or
action that ma#es at least one person better off withot hrtin% anyone is called a 'areto
impro+ement.
1f we want to compare the 'areto efficiency with incenti+e efficiency, we will notice
that both of them are based on the fact that no one can do better for themsel+es withot
anybody loosin%. 'areto efficiency may not apply on all mar#ets becase there mst be a
winner, in someone(s detriment. 3or e.ample on the monopoly mar#et, the firm that holds the
monopoly, can rise at any time the prices for ma.imi!in% their profit, ths the consmers will
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pay more money for the same ser+ice. 1n the $omanian mar#et, the instittion Electrica has
this Apower of doin% what it wants. $eferrin% to this e.ample, 1 thin# that people trst more
the mar#et mechanisms then the %o+ernments, becase %o+ernments establish the monopoly.
Ths, %o+ernments fail to pro+ide %oods efficiently for at least two reasons ,this case is find
in case of the democratic contries-4 first, breacrats inslated from competiti+e pressre can
be insfficiently moti+ated to pro+ide 9ality prodcts and to minimi!e costs. :econd, e+en
when they are flly moti+ated, breacrats may not ha+e access to the +ast flows of
information that a mar#et system atomatically pro+ides. "ost economists are cynics, bt
they aim their cynicism in different directions. :ome focs on the fact that pri+ate mar#ets are
inade9ate pro+iders of pblic %oods4 others focs on the fact that %o+ernments are fre9ently
in the %rip of special interests. Economics who are preoccpied with failres of the mar#et are
9ic# to see how %o+ernment spendin% mi%ht ser+e as a prodcti+e antidote. Those who are
preoccpied with failres of the %o+ernment are 9ic# to see how that same spendin% mi%ht
be more wastefl than the disease it is ad+ertised the cre.
'areto efficiency is an important notion in neoclassical economics with broad
applications in %ame theory, en%ineerin% and the social sciences. $eferrin% to the %ame
theory, we can say that this theory stdies the sitations when the actions of each participant
depends not only on their decisions bt also on the other(s. 1n conse9ence, the optimal
choice for a participant depends on the other(s choice. The participants of this %ame, are
called players. Each player)a firm, a consmers, a %o+ernment) acts in its best interest on the
basis of rationality principle from economy ,each player will ta#e the best decision for
himself? e.%. the prodcer will try to ma.imi!e the profit choosin% the best price to sell, while
the consmer will try to ma.imi!e the tility-.The %ame theory was pro+ed scientifically by
+on &emann and "or%enstern in 1B1C, to%ether with Theory Of Dames and Economic
7eha+ior. :o, this theory may be resmed in this way4
THE D0"E THEO$=4 The stdy of how people beha+e in strate%ic sitations
Dame4 The acti+ity which ta#es place base on e.plicit or implicit rles
:trate%y4 0 complot set of actions established by a person in response to
other person(s actions
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Mathematical theories
The seminal wor# of Leonid Hrwic! mar#s the birth of mechanism desi%n theory.
Two of the most important theories were4 re+elation principle and implementation theory. 1n
the 1BE0s, the formlation of the so)called re+elation principle and the de+elopment of
implementation theory led to %reat ad+ances in the theory of mechanism desi%n. The
re+elation principle is an insi%ht that %reatly simplifies the analysis of mechanism desi%n
problems. 1n force of this principle, the researcher, when searchin% for the best possible
mechanism to sol+e a %i+en allocation problem, can restrict attention to a small sbclass of
mechanisms, so)called direct mechanisms. While direct mechanisms are not intended as
descriptions of real)world instittions, their mathematical strctre ma#es them relati+ely
easy to analy!e. Optimi!ation o+er the set of all direct mechanisms for a %i+en allocation
problem is a well)defined mathematical tas#, and once an optimal direct mechanism has been
fond, the researcher can /translate bac# that mechanism to a more realistic mechanism. The
re+elation principle is e.tremely sefl. Howe+er, it does not address the isse of mltiple
e9ilibria. That is, altho%h an optimal otcome may be achie+ed in one e9ilibrim, other,
sb)optimal, e9ilibria may also e.ist. There is, then, the dan%er that the participants mi%ht
end p playin% sch a sb)optimal e9ilibrim. Fan a mechanism be desi%ned so that all its
e9ilibria are optimal> The first %eneral soltion to this problem was %i+en by Eric "as#in
,1BEE-. The resltin% theory, #nown as implementation theory, is a #ey part of modern
mechanism desi%n. The re+elation principle states that any e9ilibrim otcome of an
arbitrary mechanism can be replicated by an incenti+e)compatible direct mechanism. 1n its
most %eneral +ersion, de+eloped by "yerson ,1BEB, 1BG;, 1BGH-, the re+elation principle is
+alid not only when a%ents ha+e pri+ate information bt also when they ta#e nobser+ed
actions ,so)called moral ha!ard-, as well as when mechanisms ha+e mltiple sta%es. 0ltho%h
the set of all possible mechanisms is h%e, the re+elation principle implies that an optimal
mechanism can always be fond within the well)strctred sbclass consistin% of direct
mechanisms. 0ccordin%ly, mch of the literatre has focsed on the well)defined
mathematical tas# of findin% a direct mechanism that ma.imi!es the %oal fnction, sb*ect to
the incenti+e)compatibility ,1F- constraint ,and, where appropriate, also the participation
constraint-.

In conclsion, mechanism desi%n theory defines instittions as non)cooperati+e
%ames, and compares different instittions in terms of the e9ilibrim otcomes of these
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%ames. 1t allows economists and other social scientists to analy!e the performance of
instittions relati+e to the theoretical optimm. "echanism desi%n has prodced a lar%e
nmber of important insi%hts in a wide ran%e of applied conte.ts, inflencin% economic
policy as well as mar#et instittions. We ha+e discssed here some of the most important
reslts and applications.
7iblio%raphy
1. Iolt Fladi J "icroeconomics and "acroeconomics
;. Fatedra de economie si politici economice J Economie
@. &. Dre%ory "an#iw J Economics
C. :te+en Landsbr% J "acroeconomics
5. wi#ipedia.or%
H. %ardian.co.#
E. !iarlfinanciar.ro
G. sciencedaily.com
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