Monday, October 15, 2007

Art and the Nobel Prize

Three American economists won the Nobel Prize in Economics today for their work in the area of "mechanism design." GMU's Alex Tabbarok uses the following example to try to explain what mechanism design is:

"Suppose that you are selling a rare painting for which you want to raise the maximum revenue. There are two potential buyers, Tyler, who values the painting at $100,000, and Alex who values it at $20,000. The problem would be simple if you knew this information - you would then set the price at $99,999 and Tyler would buy[,] maximizing your revenue. But how much Tyler and Alex value the painting is their own private information. How then should sell the painting? One possibility that springs quickly to mind is an auction. In a standard English open-cry auction Alex and Tyler will bid for the painting and the bids will keep rising until Alex is forced to drop out at $20,001. Thus the auction earns you $20,001. Not bad but is this the maximum revenue possible? Remember that Tyler values the painting at $100,000 so you could be leaving a lot of money on the table. What else can you do?"

Read the rest of his post to find out.