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Page A5 of the October 27, 2011 issue of the WSJ displays a full page ad paid for by Allianz featuring their Chief Behavioral Economist (CBE). The CBE faces the reader while two seated individuals with their backs to us appear to gaze enraptured at the CBE. I’m presuming enraptured, because they are not in the customary prayer pose of most audience members as they check their phones. Perhaps, Behavioral economics has finally arrived. Where does the CBE stand in the hierarchy? Does he report to the Chief Economist? Is the CBE required to assiduously refrain from making predictions based on rational agents? Is the CBE’s task to train Allianz advisors in how to exploit the biases of individual investors or mitigate them? When can we expect to hear about the appointment of a Chief NeuroEconomist? Inquiring minds want to know.

I’ve continued mulling over the question of what a course in Market Design should cover and decided to take a stab at writing out at least what the beginnings of such a course would cover. Suggestions, additions, deletions and brickbats are welcome. First, a pretentious title: Principles of Market Design.

What should one assume in the way of prior knowledge? Some convexity, Linear Programming, Mas-Collel-Whinston & Green and a course in Information Economics.

Begin with Coase’s theorem. Once property rights are defined, assigned and transaction costs of bargaining are eliminated, resources should be allocated efficiently. The theorem prompts three questions:

1) Does it matter how property rights are defined?
Yes, spectrum is an example. Current property rights for spectrum were shaped by the nature of technologies present half a century ago. This in turn has influenced how we think about allocating spectrum. With current technologies we might have shaped these rights differently and the market for spectrum might be very different. Another example might revolve around the duration for permits for emissions of various noxious gases.

2) Does it matter how the property rights are assigned?
In Coase,  no. But, the initial assignment does have distributional consequences for the parties concerned.

3) What are the transaction costs that hinder efficient bargaining?
Presumably the market designer has a role to play precisely when these frictions are an obstacle.

Where next? The Myerson-Satterthwiate bargaining set up. One can use it (and variations) to make a couple of points:
a) Private information as a `transaction’ cost that impedes efficiency.
b) The Cramton-Gibbons-Klemperer variation reveals that efficiency could be recovered for a different initial allocation of property rights, i.e., the initial allocation of property rights does matter.
c) The Rustichini, Satterthwiate and Williams variation shows that as we increase the size of the market, we can get closer to efficiency. McAfee’s trick of dropping the last trade in Vickrey is also worth a mention.

The set up in (c) is, in a sense, what one might mean by a thick market. So, it is worth exploring the assumptions embedded in it. They are
1) Private values rather than common values. This would feed into adverse selection and lemons. Large markets with interdependent values…..Swinkels? Perry & Reny?
2) Co-location of buyers and sellers. Buyers and sellers know where to show up in the model. Relax that, and one has a coordination problem. A central exchange solves that problem.
3) Synchronicity. Buyers and sellers are all present at the same time. Suppose buyers and sellers arrive dynamically and can `wait’ for trading opportunities? A basic search model (which one?) would allow one to show how efficiency of trade is diminished.
4) Trade is only permitted via the exchange. What if agents can peel off and engage in transactions outside the exchange? An opportunity to talk about the core. Related to synchrony above, a desire to move at a different clock speed, i.e., unraveling. This would be related to common values above. I suppose one should connect to (2) and perhaps say something about competition between platforms.
5) Unit demand. What would happen if sellers had multiple units to offer and buyers wanted to consume more than one unit? This could lead to a discussion of the role of uniform pricing and demand/supply reduction.
6) Homogenous goods. The model assumes that sellers sell the same good. What about heterogenous goods? This could tee off a discussion of the Shaply-Shubik assignment model, substitutes preferences and discrete convexity.
7) Quasi-linear preferences. But, keep the money. What should one say here? General equilibrium? The generalizations of the assignment model due to Kaneko and Quinzii?
8) Money. One might speculate on where it comes from. Examine what can be achieved without the use of transfers.

Pausing for breath, I see I haven’t even got to distributional concerns yet or applications!

For a many years I have thought about offering a graduate level class in market design. Obligations to this, that and the other have prevented the thought becoming action. Thinking that now might be the time, I decided to set out a syllabus. As always, one first looks to copy another syllabus. There are many graduate courses on market design offered. They descend, either from Alvin Roth’s course or Paul Milgrom’s (there was a version taught by both Milgrom and Roth but I don’t know if it comes before or after their separate versions). So, market design is either matching or auction theory (if you subscribe to Hatfield and Milgrom, matching theory = auction theory! By the way, in a screech against the Matthew effect, I mention Eriksson and Karlander, Discrete Applied Mathematics (1992)). The matching theory variants appear to have reproduced without mutation hewing closely to interns, kidneys and school choice. The auction theory variants incorporate empirics and field experiments.

Is market design no more than matching, auctions and empirical IO? Shouldn’t all that has been scribbled about the regulation of markets also be called market design? However, discussions of disclosure rules, regulation of utilities and insurance providers and so forth are rarely to be found. When discussing the issue with a colleague he  suggested that market design be relabeled regulatory micro-economics. A title while more accurate conjures images of dreary bureacrats laboring in musty offices. Market design, as a label, however, has a `Randian’ quality to it. One can imagine John Galt studying it. Apparatchiks study regulatory micro-economics.

Well, when in doubt, return to the source, Roth’s manifesto (The Economist as Engineer………..Econometrica, 2002). He writes:

……….design involves a responsibility for detail; this creates a need to deal with complications. Dealing with complications requires not only careful attention to the institutional details of a particular market, it also requires new tools, to supplement the traditional analytical toolbox of the theorist.

Which reminded me of Macaulay:

……he who has actually to build must bear in mind many things never noticed by D’Alembert and Euclid.

It seems, from Roth, the objective is to strike a balance between the perspective of the parachutist (i.e. theorist) and that of the truffle hunter (domain expert). I cannot yet see how to pull this off in a class. To illustrate, consider the literature on mechanisms for assigning students to schools. There have been a flurry of papers in the last decade on this subject that are `technically sweet’. Some of the findings have changed how students are assigned to schools. However, if one felt that the market for pre-college education was `broken’ is the method by which school districts assign students to schools, the first piece one would pick up to study? More narrowly, is there any evidence that how students are assigned to schools makes a difference to educational outcomes? Thus, were one to follow Roth’s injunction to pay attention to institutional details, one is forced to become an economist who specializes in education. Nothing wrong with that. But it means that a course on market design either focuses on one topic, say, the economics of education. Or, a vehicle to introduce theorists to issues in education, healthcare, labor, financial markets etc. Much like the European bus tours of old where one spent no more than a day in any capital city.

I still wrestle with my syllabus and welcome suggestions.

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