Mechanism Design Theory – Definition

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Mechanism Design Theory Definition

Mechanism design theory refers to an approach in economics that tries to study how particular results or outcomes are achieved. Economists use this theory to compare, analyze, and regulate some instruments associated with a specific outcome’s achievement.

A Little More on What is Mechanism Design Theory

Mechanism design theory was popularized by Erick Maskin, Roger Myerson, and Leonid Hurwicz. In 2007, the three were awarded a Nobel Memorial Prize in Economic Sciences to recognize their mechanism design theory work. They were branded as the subject’s founders.

Their research has, to some extent, offered solutions to the knowledge gap that exists between sellers and buyers as well as the market’s efficient operation consequences. According to the Nobel Committee, the theory helped to distinguish situations working in the market and those that don’t. By using the approach, economists were able to identify regulation schemes, efficient trading mechanisms, and voting procedures.

Despite the theory being highly abstract, its application in real-world situations is concrete. It has been able to justify the interventions of government as far as operational markets such as health care are concerned. It helps in constructing rules that prevent disparity in information between groups of sellers and buyers. The gap in knowledge is known as information asymmetry in economics, and it is currently the most studied discipline.

Mechanism Design Theory vs. Financial Markets

There has been the development of several mathematical theorems because of the many applications for mechanism design theory. The assumptions and applications make it easy for researchers to manage information and restrictions control of the involved entities so that they can come up with the desired results.

An excellent example of a place where the mechanism design theory can be applied is in auction markets. The regulators’ primary aim in those markets is to produce an orderly and efficient market for participants. For them to achieve this, they involve several entities with different associations and information levels. They use mechanism design theory to control and regulate information that is available to participants so that they can achieve their desire to have an orderly market. To properly accomplish this, it requires monitoring of activity and information at different levels for market makers, exchanges, sellers, and buyers.

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