Personalized Resource Allocation Mechanisms

Yale University, New Haven CT

Investigators

Abstract

Economists have a good understanding of competitive markets, whose supply-and-demand diagrams are the staple of introductory textbooks and the source of much of our economic intuition. Competitive markets are characterized by large numbers of sellers featuring identical products and large numbers of buyers, all with good information about trading possibilities. As a result, participants in this market have no effect on the market price, and do not care who they trade with?buyers are just as happy to trade with one seller as another, and sellers as happy to trade with one buyer as another. Prices have relatively little to do in such markets, serving to balance the quantities supplied and demanded, with the remaining details of how trade occurs and who trades with whom being largely irrelevant. It is thus no surprise that competitive markets work relatively well. Much of current economic theory is concerned with the many markets in our economy that are not competitive. It is well understood that markets will not be competitive when there are only a few buyers or sellers, large enough to affect prices through the exertion of market power, and a rich literature in industrial organization has emerged to examine such markets. The research described in this proposal is instead concerned with cases in which markets create asymmetries that distinguish agents, giving rise to personalized relationships (rather than the anonymous interactions of competitive markets). How are resources allocated in such personalized markets? The research begins by examining markets in which people must undertake investments before they can trade?potential employees may acquire skills, just as employers may invest in capital equipment. These investments introduce a matching component in the subsequent market, as people vie to trade with desirable partners. The appropriate legal and institutional structure, including especially the appropriate assignment of property rights, turns out to be critical for prices to do an effective job of clearing such markets. This project gives us a new understanding of this relationship, potentially leading to the possibility of designing more effective matching markets. A second component of the research examines relationships in which people repeatedly deal with one another, sometimes sacrificing short-term gain in the interests of a more effective long-term interaction. Technically, the research advances the theoretical tools used to examine such relationships, namely the theory of repeated games under incomplete information. More concretely, the investigator applies these tools to model specific economic questions involving resource allocation and price formation. Finally, the research considers cases in which economic interactions are personalized rather than anonymous because the preferences of the parties are linked, with each having some regard for the welfare of the other. The intellectual goal is a better understanding of resource allocation and economic behavior. A running theme is that personalized interactions often complement or even replace prices and markets in allocating resources. Taking a longer term view, this research enhances our understanding of how to better allocate resources through the design of more effective markets.