Monday, October 25, 2010

Pricing, Mechanism Design and Efficiency

In an effort to make it more accessible, Jeff Ely has a nice and concise discussion of the Myerson-Satterthwaite theorem. Here's a key paragraph:
The problem is one of information. If B is going to be induced to sell to A, the price must be high enough to make B willing to part with the good. And the more B values the good, the higher the price it must be. That principle, which is required for market efficiency, creates an incentive problem which makes efficiency impossible. Because now B has an incentive to hold out for a higher price by acting as if he is unwilling to part with the good. And sometimes that price is more than A is willing to pay.
If you prefer reading through slides for a demonstration of this idea, here's the set of slides he used to ground his intuition (and teach his intermediate microeconomics class). If he's trying to make the idea easy to understand, I think it is a success.

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