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Jewish World Review Nov. 1, 2007 / 20 Mar-Cheshvan 5768 Nobel Prize in Economics — where Team USA still dominates the game By Jonathan V. Last
http://www.JewishWorldReview.com | Remember the Cold War era, when people obsessed over the medal count during the Olympics? We loved watching plucky American amateurs clobbering the mechanical, godless Reds, every one of them - even their little teenage gymnasts - looming like Ivan Drago. Alas, the Olympics have lost some of their luster after the fall of communism. Gone is the thrill of nationalist rah-rah. It's our Nike-endorsing, semiprofessional athletes against everyone else's Nike-endorsing, semiprofessional athletes, and basically, we're all friends now. Boring. Everyone needs to get his jingoistic kicks somewhere, though. I get mine from the Nobel Prize awards. America has never fared particularly well in the Peace or Literature events, taking home only 20 medals in the former and a disgraceful 12 medals in the latter. Since the 1930s, we've done well in Medicine and have been quite strong in both Chemistry (42 medals) and Physics (53). But it's the Sveriges Riksbank Prize in Economic Sciences - more commonly known as the Nobel Prize in Economics - where we dominate. We're the New York Yankees of economic theory, having won or shared the prize in 29 of the 39 years it's been given. If a snooty European ever tries badgering you about climate change, or the state of Team USA basketball, or Iraq, just say, "Yeah? Well, we own the Sveriges Riksbank Prize." That's how you end an argument. Recently, like any fan, I was sitting at home covered in red, white and blue body paint, just waiting for the announcement of this year's award. I was pretty juiced when the committee gave it to Leonid Hurwicz, Eric S. Maskin and Roger B. Myerson, because in addition to the normal welling of national pride, Hurwicz, Maskin and Myerson are pioneers in a particularly interesting branch of economics: mechanism-design theory. Mechanism-design theory is an offshoot of the more popular field of game theory. When you hear the words game theory, you probably think of Russell Crowe and Jennifer Connelly from the movie "A Beautiful Mind," which was supposedly about John Nash, the father of game theory. (And yet another American Nobel winner, for those of you keeping score at home.) Heavy on the romance and melodrama, "A Beautiful Mind" was light on the basics of game theory, which boil down to this: An economic "game" is one where actors make decisions by seeking to maximize the outcomes of situations that depend, in some part, on the decisions made by other actors, who are also seeking to maximize their outcomes. The classic "prisoner's dilemma," for instance, is a situation ripe for the application of game theory. Mechanism-design theory accepts the ground rules of game theory, but concentrates on finding sets of rules that can help actors maximize outcomes. Consider the following example: Andy owns a widget and is considering selling it. Donovan would like to buy a widget. That widget carries a specific, but probably different, dollar value for each man. Andy won't sell the widget unless Donovan's value is higher than his. And - here's where the game theory comes in - neither man will tell the other truthfully what his valuation of the widget is. That's because if Andy is honest, Donovan can offer him just $1 more, even if his valuation is much higher; conversely, if Donovan is honest, Andy could accept that amount, even if his valuation is much lower. So we have a conundrum. It's a general economic principle that private information - that is, stuff you know that other actors don't - is a huge source of inefficiency. Andy and Donovan each have private information about how they value the widget, and although they may be able to haggle out a price, it may not be the optimal price that creates the most net value. Which is where mechanism-design theory comes in. Using the principles of mechanism-design theory, an economist could study Andy, Donovan and the widget and figure out a method of sale that could get the best deal for both of them. That might entail the use of a Dutch auction (start high and come down until someone bids, or until you hit the seller's minimum acceptable price), or an English auction (start with the lowest acceptable price and work bidders off against one another to jack it up). It might even call for a double-auction, where each party announces its bid/ask price, with the widget to be sold at the point halfway between the two. Even in this streamlined example, you can see where mechanism-design theory exists all around us as people create systems to help buyers and sellers come together. One of the great mechanism designs of recent years has been iTunes, a system that helped overcome the "private information" at the heart of the music industry: namely, what the songs in the middle of a CD (which were always the hardest to get to hear) sound like and how much an individual values a given piece of music. Unbundling collections of songs and offering them at a uniform, fixed price is an elegant mechanism. So three cheers for America's latest stud economists. Dismal science? Only for the rest of the world. Every weekday JewishWorldReview.com publishes what many in in the media and Washington consider "must-reading". Sign up for the daily JWR update. It's free. Just click here. Jonathan V. Last is a columnist for the Philadelphia Inquirer. Comment by clicking here.
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