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Based on the recent development of epistemic game theory, this chapter attempts to resolve longstanding contested issues across social science disciplines about the nature and origin of institutions. These issues include: institutions as a pre-play design vs. spontaneous order, deontic constraints vs. rational choice, regularity of actions vs. shared meanings, endogenous and exogenous views, and so on. It argues that for a societal order to evolve through the recursive play of societal games, some social cognitive categories such as formal laws, norms, rules, and ritual, and organizations need to mediate between physical actions and the behavioral beliefs of individual players. Thus, pure methodological individualism must be laid to rest in institutional analysis. From such perspectives this chapter describes how institutions evolve and what the roles of business corporations can be in that process.

This chapter reviews the relevant anthropology, starting with the apparent universality of the golden rule — do as you would be done by — in hunter-gatherer societies. It points out that all pure foraging societies have two properties: they do not tolerate bosses, and they share very fairly. A putative explanation of the first property is offered that appeals to the game theory discipline of mechanism design. The second property is explained as an evolutionary consequence of the implicit insurance contracts that are common in animals as ahedge against hunger and starvation. If so, then we have an argument in support of the contention that Rawls' original position captures the deep structure of fairness norms wired into our brains. The analogy with Chomsky's deep structure of language is close.

This chapter discusses how auction theory under independent types can be presented as a mechanism design problem. It is shown that any two mechanisms that allocate the object in the same way and yield the same expected surplus to the individual with the lowest type will generate the same expected revenue for the seller. A general version of the Revenue Equivalence Theorem is presented and the optimal auction is characterized.

This chapter uses the Prisoner's Dilemma as the linking idea in an overview of many of the topics covered later in the book. The basic ideas are that of a dominated strategy and a Pareto-efficient outcome. Various fallacies that promote the latter notion over the former are considered. At the same time, the chapter introduces problems in the private provision of public goods, the economic theory of imperfect competition, repeated games, the tragedy of the commons, and mechanism design. The idea of a Nash equilibrium is introduced.

School choice has presented economists with opportunities to study and design student assignment systems, which in turn have helped push forward the frontiers of mechanism design theory. This chapter discusses the student assignment problem in school choice, related issues, assignment mechanisms and new developments in the theory and practice of mechanism design within the context of school choice.

The chapter describes a mechanism design framework that could help identify a set of procedural mechanisms that would minimize the resources used to achieve one of the main goals of the court system, which is to differentiate between those who obeyed the law and those who did not. The proposed framework can also help to formulate and evaluate procedural rules, and to identify necessary and sufficient conditions for deciding disputes according to substantive law with minimal costs of litigation and delay. The chapter illustrates our approach using three examples: fee-shifting rules, discovery rules, and third party alternative dispute resolution mechanisms.

This chapter begins by summarizing the mechanics governing kidney donations. There are two sources of donation: deceased donors and living donors. It then analyzes the kidney exchange problem as a dynamic problem in which patients arrive over time under a stochastic distribution. It proposes efficient mechanisms that maximize the total discounted number of patients matched under different institutional restrictions. It also discusses computational issues involved in solving the optimization problems with the mechanism design approach. Finally, the chapter considers other paradigms in kidney exchange, such as list exchange, altruistic donor exchange, and altruistic donor chains, and how these are incorporated in the market design paradigm.

This chapter provides an informal survey of the key questions of the theory of mechanism design. The chapter then outlines the analytical approach that the theory of mechanism design takes to address these questions.

A new and general framework for informationally robust mechanism design is developed. Standard results are integrated into this framework. Paradoxes that arise in this framework are explained. The framework is explained in a voting example. The importance of simplicity of mechanisms for the theory of robust mechanism design is emphasized.

This chapter describes a new auction for differentiated goods — the ‘Product-Mix Auction’ — that was designed and implemented after the 2007 Northern Rock bank-run to help the Bank of England fight the financial crisis. The Bank now uses it regularly, and successfully. Bidders bid on multiple assets simultaneously, while bid-takers simultaneously choose supply functions across assets. The auction yields greater efficiency, revenue, information, and trade than running multiple separate auctions. It is often simpler to use and understand, and less vulnerable to collusion, than a simultaneous multiple round auction. Future applications might include purchasing ‘toxic assets’, selling electricity, and trading biodiversity.

This chapter reviews the basics of static mechanism design in settings where a principal faces a single agent of uncertain type. The aim of the resulting screening contract is for the principal to obtain the agent’s type information in order to avert adverse selection, maximizing her payoffs. Nonlinear pricing is discussed as an application of optimal control theory.

One aspect of financial markets that is of great relevance to economic development is the study of credit mechanism design by lenders facing private information. This chapter first develops a model of moral hazard in a rural credit market, beginning with the benchmark case of perfect competition under complete information. It then compares the loan contract offered by non‐local lenders who cannot monitor payoff‐relevant actions of borrowers with that offered by an informed local monopolistic moneylender and examines what happens in a fragmented market where villagers can choose between either contract. The next section develops, along similar lines, a model of adverse selection. The inefficiencies arising in these contracts, the potential mitigating role of collateral, and the possibility of local moneylenders earning informational rent are lessons that emerge from these models.

The appearances of game theory in evolutionary biology in the 1970s foreshadowed the theory’s widespread adoption in the social sciences in the 1980s. During this latter period, the analysis of repeated “supergames” and, especially, the “non-cooperative” Nash Equilibrium solution concept for games (of which the evolutionarily stable strategy was a particular refinement), entered the mainstream of economic theory. This chapter therefore examines the nature of this brand of game theory’s appeal in the social sciences. Non-cooperative game theory held out the possibility of grounding an ultimate theory of society in parsimonious assumptions of individual self-interest, thereby also knitting together game theory’s normative, descriptive, and predictive aspects. This agenda sought to distinguish itself from von Neumann and Morgenstern’s earlier “cooperative” game theory and the “mathematical-institutional” approach to economics, with their insistence on the plurality of logically possible social orders. But even as non-cooperative game theory took off within economics during the 1980s, the hunt for non-cooperative solutions to games began to run into technical problems and interpretive challenges. As a result, even as game theory established itself as a widely-adopted modeling idiom in the social and biological sciences, its internal diversity and interpretive flexibility began to reassert itself.

A second desideratum of good organizational design is incentive compatibility. This is satisfied to the extent that group members are given incentives to act in a way that supports an expected mode of group behavior; the expected behavior may be truthfulness in some contexts, cooperativeness in others. There are at least two routes by which we may promote incentive compatibility. One, the organizational route, takes people's behavioral dispositions as given and seeks to set up an organizational structure that produces the appropriate aggregate result on the basis of those dispositions. The other, a behavioral route, takes the organizational structure as given and looks for ways of changing people's behavioral dispositions — these measures might be educational, communicative or social — so as to produce a suitable result. Each route poses considerable difficulties, whether put into operation alone or in conjunction with the other; incentive-compatibility is a particularly elusive goal.

This chapter looks at the career of Eric S. Maskin, Nobel Prize recipient in 2007. Maskin was born in 1950 and completed his doctorate in mathematics at Harvard University in 1976. Ken Arrow, Leo Hurwicz, and Andy Postlewaite influenced Maskin's decision to switch his specialism to economics. He became a professor of economics at MIT in 1981 and an Adams University professor at Harvard in 2012. He worked on mechanism design, the engineering part of economic theory. Two applications of mechanism design theory he is very concerned with are climate change and the ongoing financial crisis. Taxation, Incomplete Markets and Social Security and Reforming Pensions: Principles and Policy Choices, 2008 are two of his key works.

The classic Bayesian theory of mechanism design is developed in three simple examples: auctions, public goods, and bilateral trade. The classic results, such as the revelation principle and the revenue equivalence theorem, are explained in the context of these examples. Both revenue and welfare maximization are considered.

This chapter deals with auctions and mechanism design commonly referred to as the rules of the game. In problems concerning bidding and public auction, many principles should be considered as part of the rules toward solving them. In the revelation principle, the researcher should consider only the truth-telling equilibria as it is impossible to consider all possible mechanisms. Or he can examine the constraints of the principle such as incentive, participation, and physical constraints. One or more of these constraints will help explain some of the actions and decision of a particular player. For example, the physical constraint states that a player is not allowed to do anything physically impossible. In real life, this design is often encountered in bidding and auctions. Thus, a person bidding for an object in an auction cannot offer more than what he actually has.