Overview

Usually, economists look at a market and ask “What happens?” Mechanism Design asks “What do we want to happen, and how do we write the rules to make it happen?” It is “Reverse Game Theory.” It is the engineering side of economics.

Core Idea

The core idea is Incentive Compatibility. Designing a game where the best strategy for the player is to tell the truth and do what the designer wants.

Formal Definition

The art of designing rules of a game to achieve a specific outcome, even when players are self-interested and have private information.

Intuition

  • Cake Cutting: You want two kids to share a cake fairly.
    • Bad Rule: Mom cuts it. (Kids complain).
    • Mechanism: “I cut, You choose.”
    • Result: The first kid cuts the cake perfectly in half, because he knows the second kid will take the bigger piece. Fairness is achieved through selfish incentives.

Examples

  • Auctions: How do you sell a painting for the highest price?
    • English Auction: Ascending bids.
    • Vickrey Auction (Second-Price Sealed-Bid): Everyone writes down a bid. The highest bidder wins, but pays the second highest price. This forces people to bid exactly what they think the item is worth (Truth-telling).
  • Kidney Exchange: People want to donate kidneys to their spouses, but blood types don’t match. Al Roth designed a mechanism to swap donors. “I give to your wife, you give to my husband.” It saved thousands of lives.

Common Misconceptions

  • It’s just for money: It’s used for voting systems, school choice (assigning kids to public schools), and organ donations.
  • The Revelation Principle: Any outcome that can be achieved by a complex game can also be achieved by a simple game where everyone tells the truth.

Applications

  • Google AdSense: The auction that runs every time you load a webpage. Advertisers bid for your attention in milliseconds. It is a masterpiece of mechanism design.

Criticism / Limitations

  • Complexity: Real people are confusing. A mechanism that works on paper might fail if people don’t understand the rules.

Further Reading

  • Roth, Alvin. Who Gets What — and Why.