In 2012, Alvin E. Roth was awarded the Nobel Prize alongside Lloyd Shapley in the field of applied game theory for his work concerning stable allocations in market design. In June of this year, Roth published Who Gets What — and Why: The New Economics of Matchmaking and Market Design, a book that sounds like a general introduction to the study of matching markets but often reads like a listing of case studies. Roth spends most of his time explaining research and projects he himself has been involved in, adding definitions and explanations of concepts as an aside. This approach is not bad in and of itself, but it does make the title seem a little misleading.
Roth explains that a matching market is a market in which price is not the sole determinant of who gets what. An obvious example of this is the marriage market: usually you can’t simply pay someone a sum of money and expect them to marry you. Any functioning market, matching or otherwise, has three basic characteristics. They are thick, meaning there are lots of people participating and transacting with each other. They have the means to deal with congestion, meaning they make it possible for lots of people to transact together in a timely manner. And they are safe, meaning lots of people trust the marketplace and are willing and eager to participate. At heart, these three aspects are all concerned with the transmission of essential information. We use marketplaces to gather information about market participants (relayed by their preferences) in order to efficiently allocate society’s resources. An efficient allocation is one in which no participant could be made better off by transacting outside the marketplace (what Roth calls a “blocking pair”). For this collection of information to occur, there must be many participants willing to reveal their true preferences. Markets fail when they are thin, congested, or unsafe. These markets allocate resources inefficiently, and thus we often find people transacting outside the official marketplace in the knowledge that they can find themselves a better deal.
Without the market-clearing power of prices, matching markets are especially prone to these failings. Roth gives an example we can all relate to: the college admissions process. It is no secret that the rate of college applications has been growing over the past several decades. The Common App was created in order to deal with this congestion. Many colleges now use the Common App in their application process because of the thick market it provides. However, there is a downside. With just one application form, it is easy for students to apply to many colleges, even if they aren’t all that interested in attending. How do colleges get information on which students they actually have a chance at enrolling? The supplemental essays– only a student truly interested in attending will take the time to write yet another 500 words. Thus, the Common App wasn’t enough to ease this market’s congestion. While it made it possible for the students to apply to more schools, it forced the colleges to find a way to gather better information on their applicants’ preferences.
Markets naturally evolve this way, through gradual changes that allow participants to make better transactions. Of course, markets still exhibit many inefficiencies. The relatively new field of market design studies the aspects of natural markets that work well in the hopes of tweaking these markets to make them run even smoother or of solving the failings of hopelessly inefficient markets. Roth points out that markets are a human invention, meaning we have more control over them than the processes of biological evolution. Still, when tweaking or designing markets we cannot forget that we are fiddling in a process built by the collective action of billions of people. We cannot simply impose our will: we must accept human nature as it is and carefully examine the effect a particular market design will have on an individual’s incentives and strategies (this is where game theory comes in). Only then can we be sure we will have a thick market with eager and willing participants. In Roth’s words, “The lesson of market design for political debate is that to understand how markets should be operated and governed, we need to understand what rules particular markets need.” (pg. 227)
In the interests of keeping this post short, I won’t discuss any of Roth’s detailed case studies here. However, you can go to http://www.nobelprize.org/mediaplayer/index.php?id=1879
to watch his Prize Lecture, where he explains his work in medical field labor markets, school choice in US cities and kidney exchanges, all subjects he writes about in the book. If you are interested in a more general approach to the study of markets, John McMillian’s Reinventing the Bazaar: A Natural History of Markets is a great introduction. Both of these books were recommended to me by Professor Campbell.
Written by Lauren Hurley