Mechanism design theory

Mechanism design is a field in economics and game theory that takes an engineering approach to designing economic mechanisms or incentives, toward desired objectives, in strategic settings, where players act rationally. Because it starts at the end of the game, then goes backwards, it is also called reverse game theory. It has broad applications, from economics and politics (markets, auctions, voting procedures) to networked-systems (internet interdomain routing, sponsored search auctions).

Mechanism design studies solution concepts for a class of private-information games. Leonid Hurwicz explains that 'in a design problem, the goal function is the main "given", while the mechanism is the unknown. Therefore, the design problem is the "inverse" of traditional economic theory, which is typically devoted to the analysis of the performance of a given mechanism. So, two distinguishing features of these games are:

The 2007 Nobel Memorial Prize in Economic Sciences was awarded to Leonid Hurwicz, Eric Maskin, and Roger Myerson "for having laid the foundations of mechanism design theory".

In an interesting class of Bayesian games, one player, called the "principal", would like to condition his behavior on information privately known to other players. For example, the principal would like to know the true quality of a used car a salesman is pitching. He cannot learn anything simply by asking the salesman, because it is in his interest to distort the truth. Fortunately, in mechanism design the principal does have one advantage: He may design a game whose rules can influence others to act the way he would like.

Without mechanism design theory, the principal's problem would be difficult to solve. He would have to consider all the possible games and choose the one that best influences other players' tactics. In addition, the principal would have to draw conclusions from agents who may lie to him. Thanks to mechanism design, and particularly the revelation principle, the principal need only consider games in which agents truthfully report their private information.

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