Market Failure

Market failure is described and discussed. A summary of the current state of understanding is provided. Key words are: market failure, public good, externalities, rational expectations, information, monopoly, and competitive equilibrium

Incentive Compatibility and Incomplete Information

It is by now reasonably well known that when informationally decentralized processes are used to make collective choice decisions or to allocate resources, individuals may find it in their interest to distort the information they provide and that these distortions may lead to non-optimal group decisions. In the social choice context, this has been formalized in the Gibbard-Satterthwaite Theorem, which states that all non-dictatorial rules will have this property. In a different context, Hurwicz has shown that there is a private goods neo-classical exchange economy such that any decentralized mechanism which selects Pareto-optimal allocations and which has a no-trade option will have this property. Roberts has provided a similar example in the public goods context. Other work (e.g., Green-Laffont, Groves-Loeb, Hurwicz, and Walker) indicates that, for mechanisms designed to select efficient outcomes, in most environments some agent will have an incentive to misrepresent his information and thus to manipulate the mechanism. All these results lead one to the conjecture that it is almost impossible to design any mechanism for group decisions which is compatible with individual incentives and efficiency

Incentive Compatibility

Incentive compatibility is described and discussed. A summary of the current state of understanding is provided. Key words are: incentive compatibility, game theory, implementation, mechanism, Bayes, Nash, and revelation

The economics of the space station

Space exploration and development are naturally conducted on the cutting edge of science and technology. Such efforts inevitably involve decisions made in the presence of extensive uncertainty. For some projects, particularly those which involve the creation and maintenance of an infrastructure, the emphasis is switching from specific engineering goals (for example, a man on the moon by 1969) to more diffuse, continuing, multiple-dimensional goals. This is especially true of the space station, which is envisioned as both a vital link in the exploration of the planets and a major facility for the advancement of commercial efforts in space. The combination of uncertainty and diffuse, long-term goals fundamentally alters the viability and validity of traditional economic and engineering approaches to the management of large public research and development projects. It has become popular to call into question the recent management of continuing projects like the space shuttle or major new weapons systems. We must, however, recognize that cost overruns, gold plating and other forms of apparent mismanagement are usually not the result of individual venality and misbehavior but only the natural outcomes of the existing organizational rules of the game. Just as the performance of an engineering design is guided by the laws of physics, the performance of an organizational design is guided by the laws of behavior. This fact means that to improve performance we cannot simply add more or better manpower; rather, we must look for new organizational solutions. There are many ad hoc opinions about how to do this; what I propose is a more systematic, scientific approach. This paper examines some of the economic and management issues which must be addressed if the space station is to effectively and efficiently pursue the myriad goals that have been chosen for it. I characterize and evaluate in a somewhat stylized fashion three possible policies: an "engineering" approach, an "economics" approach, and a systematic custom design approach. I will use the space station as an example to highlight some of the major economic issues facing large-scale multipurpose research and development efforts, the analytical capabilities we now have to address these issues, and the (non-engineering) research that needs to be done to advance the successful long-term development of space

The Paradox of Voting and Candidate Competition: A General Equilibrium Analysis

Conventional analysis of the decision of expected utility maximizing agents to vote has concluded that it is irrational to vote unless voters have a distorted view of their individual impact or place a direct value on the act of voting. On the other hand, mathematical analyses of the electoral process (see, e.g., Davis, Hinich, Ordeshook (1970)), have usually assumed that all voters vote. Each theory is incorrect in the sense that in actual elections turnout is neither zero nor 100%. In this paper we will argue that previous analyses of expected utility maximizing voters s topped too soon because of the partial equilibrium approach and that if each voter considers the simultaneous reactions of all voters in a "rational" manner, then depending on the location of the candidates' platforms, turnout will usually be positive but less than 100%. In particular we will derive a (probabilistic) vote supply function, given a distribution of voters and the choice of platforms of candidates, which has the property that, even with costs of voting, unless the candidates have identical platforms, the expected turnout is positive. The model and these results are presented in sections 1a and 1b

The Scope of the Hypothesis of Bayesian Equilibrium

What behavior can be explained as the Bayes equilibrium of some game? The main finding is almost anything. Given any Bayesian (coordination) game with positive priors and given any vector of nondominated strategies, there is an increasing transformation of each utility function such that the given vector of strategies is a Bayes (Nash) equilibrium of the transformed game. Any nondominated behavior can be rationalized as Bayes equilibrium behavior. Some comments on the implications of these results for game theory are included

The Existence of Efficient and Incentive Compatible Equilibria with Public Goods

In our previous paper, "Optimal Allocation of Public Goods...," (1977) we presented a mechanism for determining efficient public goods allocations when preferences are unknown and consumers are free to misrepresent their demands for public goods. We proved the basic welfare theorem for this model: If consumers are competitive in markets for private goods and follow Nash behavior in their choice of demands to report to the mechanism, then equilibria will be Pareto optimal. In this paper we show this result is not vacuous by proving that an equilibria will be Pareto optimal. In this paper we show this result is not vacuous by proving that an equilibrium will exist for a wide class of economies. Our conditions are slightly stronger than those required to prove the existence of a Lindahl equilibrium. In order to rule out the possibility of bankruptcy, we assume additionally that at all Pareto optimal allocations, private goods consumption is bounded away from zero

Learning to alternate

The Individual Evolutionary Learning (IEL) model explains human subjects’ behavior in a wide range of repeated games which have unique Nash equilibria. Using a variation of ‘better response’ strategies, IEL agents quickly learn to play Nash equilibrium strategies and their dynamic behavior is like that of humans subjects. In this paper we study whether IEL can also explain behavior in games with gains from coordination. We focus on the simplest such game: the 2 person repeated Battle of Sexes game. In laboratory experiments, two patterns of behavior often emerge: players either converge rapidly to one of the stage game Nash equilibria and stay there or learn to coordinate their actions and alternate between the two Nash equilibria every other round. We show that IEL explains this behavior if the human subjects are truly in the dark and do not know or believe they know their opponent’s payoffs. To explain the behavior when agents are not in the dark, we need to modify the basic IEL model and allow some agents to begin with a good idea about how to play. We show that if the proportion of inspired agents with good ideas is chosen judiciously, the behavior of IEL agents looks remarkably similar to that of human subjects in laboratory experiments

The existence of efficient and incentive compatible equilibria with public goods

In our previous paper, "Optimal Allocation of Public Goods...," (1977) we presented a mechanism for determining efficient public goods allocations when preferences are unknown and consumers are free to misrepresent their demands for public goods. We proved the basic welfare theorem for this model: If consumers are competitive in markets for private goods and follow Nash behavior in their choice of demands to report to the mechanism, then equilibria will be Pareto optimal. In this paper we show this result is not vacuous by proving that an equilibria will be Pareto optimal. In this paper we show this result is not vacuous by proving that an equilibrium will exist for a wide class of economies. Our conditions are slightly stronger than those required to prove the existence of a Lindahl equilibrium. In order to rule out the possibility of bankruptcy, we assume additionally that at all Pareto optimal allocations, private goods consumption is bounded away from zero