Perspectives on Mechanism Design in Economic Theory

Abstract

Economics began with Xenophon’s Oeconomicus (c 360 BCE), in which Socrates interviews a model citizen who has two primary concerns. He goes out to his farm in the country to monitor and motivate his workers there. Then he goes back to the city, where his participation in various political institutions is essential for maintaining his rights to own this farm. Such concerns about agents’ incentives and political institutions are also central in economic theory today. But they were not always. Two centuries ago, economics developed as an analytical social science by focusing on produc tion and allocation of material goods, developing methodologies of national-income accounting and price theory. Questions about resource allocation seemed particularly amenable to math ematical analysis, because flows of goods and money are measurable and should satisfy flowbalance equations and no -arbitrage conditions. From this perspective, the classical economic problem was that people’s ability to satisfy their desires is constrained by limited resources. The classical economic result was that unrestricted free trade can achieve allocative efficiency, in the sense that reallocating the available resources cannot improve everyone’s welfare. A shift of focus from allocation of resources back to analysis of incentives began from the time of Augustin Cournot (1838), when economic theorists began to analyze optimal decisions of rational individuals as a tool for understanding supply and demand in price theory (see Jurg