The prize has been awarded to Peter Diamond, Dale Mortensen and Chris Pissarides.
First, let me bask in some Nobel glory and say “I called it!”: in a post last week, I used the Kellogg/NU data to predict this prize. This goes to show that “information aggregation and voting” has one data point in its support.
Dale Mortensen is at Northwestern so I know him a little. I remember having a very fun conversation with Dale and his wife and Ed Prescott (before he won the Nobel Prize himself) at a Schwartz dinner at Northwestern. There was a quite lively discussion of the Iraq war led by Dale’s wife. I’ve never met Chris Pissarides. All I can say as someone raised in the U.K. is that it’s great that a professor at L.S.E. won the Prize. L.S.E. is an amazing intellectual, cosmopolitan institution. Hayek and Coase spent formative years there. It’s wonderful that Pissarides got his PhD at LSE and has spent almost his entire career there. I visited MIT last year but I was too intimidated by Diamond to strike up a conversation!
Here is my attempt to offer some explanation of some papers. My choices are somewhat idiosyncratic as they are the papers I have read rather than perhaps their key papers.
Peter Diamond has a classic paper A Model of Price Adjustment in the Journal of Economic Theory in 1971. Diamond shows that even an infinitesimal search cost can lead to monopoly pricing rather than competitive pricing because of a hold up problem. Suppose there is no search cost and two firms are selling an identical good. The logic of (Bertrand) competition means they will both end up pricing at cost. At any higher price, one firm can undercut the other and capture the entire demand rather than half the demand and double its profit.
Instead suppose there is a small search cost e>0 a consumer must pay to discover the price. Pricing at cost is no longer an equilibrium – one firm can raise its price by almost e. The consumer discovers the higher price once he enters the store. But going to the other store to get a lower price involves a transactions cost of e anyway. So, it is better to submit to hold-up and pay the higher price. This logic obtains at all prices lower than the monopoly price. At that point you do not want to raise the price any more as consumers simply stop buying at a rate than makes further price increases lead to lower profits. So, a small search cost reverses the intuition about pricing completely.
Diamond has made seminal contributions to many areas. He has worked on general equilibrium with incomplete markets, the overlapping-generations model and on public finance (Diamond-Mirrlees).
Of Dale Mortensen’s papers, I know Property Rights and Efficiency in Mating, Racing and Related Games in the American Economic Review in 1982. Suppose parties are trading and have to invest ex ante to increase the ex post value of trade. The investment could be search for a trading partner or R-and-D investment etc. If they do not trade, each goes back into the search market to trade with someone else. If they do trade, any surplus they generate is split 50-50. The latter property implies there a kind of tax on ex ante investment and generates underinvestment. In common with Diamond, there is not only search but also ex post hold-up. In Diamond, the price can be increased by the firm behind the veil of secrecy. In Mortensen, ex post haggling over price generates hold-up. The Mortensen model in AER is closely related to the Grossman-Hart model of incomplete contracts and property right allocation and also to last year’s prize to Oliver Williamson.
Pissarides’s AER 1985 paper Short-Run Equilibrium Dynamics of Unemployment, Vacancies, and Real Wages also assumes unemployed workers and firms bargain over wages ex post. Their share of the surplus depends on their outside option which is turn depends on the tightness of the labor market – intuitively, the more workers are unemployed, the lower the wage firms can charge. In fact, in the simple model Pissarides proposes, it is possible to derive explicit solutions relating unemployment to wages and vacancies and even take the model to data. Hence, the Diamond-Mortensen-Pissarides model has become a canonical model with which to study unemployment. It has been extended in many directions by many authors including Mortensen and Pissarides together.
I guess the DMP model is being used to study unemployment dynamics in the current recession and to propose policy responses. A highly timely prize.
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October 11, 2010 at 9:40 am
Jonathan Haskel
Chris Pissarides was my PhD supervisor when I was at the LSE. In addition to the papers that you cite, he has also written extensively with Dale Mortensen. I would say the prize is very richly deserved. It’s a reward for what we value in our profession: scholarly, insightful work that provides a foundation for empirical work and new theory questions. Indeed, noone in Economics should complain about awarding a prize to a rich and insighful description of supply, demand and price determination in markets! For those of you who have not met him, Chris is a great guy: super clear in lectures and seminars and generous with comments and suggestions (I am the opposite to Sandeep, I have not met Mortensen and Diamond).
October 11, 2010 at 9:51 am
Sandeep Baliga
Thanks for you comment, Jonathan. I should have added that I’m a micro theorist not a labor/macro theorist so my reading in this literature is driven by my interest in the theory of the firm and contract theory and is quite idiosyncratic.
October 11, 2010 at 12:44 pm
Peter Diamond, Dale Mortensen, and Christopher Pissarides Win Nobel Prize - CBS MoneyWatch.com
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October 11, 2010 at 2:53 pm
A Nobel Prize for Hayekian recalculation in the labor market | Taking Hayek Seriously
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October 11, 2010 at 3:05 pm
Jay Banks
I agree with the winning statement. Their scientific asset assumes next very important data for development of the labor market. I don´t meet anyone person of this super trio, but I´m interested in behavioral economics, which is the main domain of Peter Diamond.
October 11, 2010 at 6:20 pm
ProfDC
I explain the Diamond paradox, which bridges IO and the economics of information, a little differently, using decision theory rather than a hold-up argument, and arguing against price cuts rather than for price increases.
Let’s say a consumer gets the price at one store free but has to pay a small amount to get another quote. Under what conditions would a consumer pay the small search cost to search another store? Only if he expected that he’d get a price reduction sufficiently often (and of large enough magnitude) to, in expectation, exceed the search cost. That’s a complicated calculation but a simple implication is that, for search to be “worth it”, the consumer needs to believe that there is some price variation among sellers; if all sellers charge the same price, search can never be optimal.
Now let’s think about the pricing incentives for the firms. If every consumer were to buy at the first store they visit, there’s no incentive for any store to offer a price reduction to gain business; either a consumer falls into your store or they don’t, and there’s no increase in quantity sold by reducing your price (basically, the opposite of Bertrand logic) so you might as well price at the monopoly level. If consumers don’t search, the stores thus all charge the monopoly price, which means there’s no price variation — which leads to the correct consumer response to be to buy at the first store. Thus, monopoly pricing (and no search) is an equilibrium.
October 14, 2010 at 6:43 am
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October 17, 2010 at 6:37 am
sebhel
If only it was so easy. The problem is all to do do with deception. Most of us have the human trait called gullibility ie. trust and helpfulness(*). We should be proud of this as it is the core of man’s survival. Unfortunately a minority of deviant opportunists can exploit this “weakness” and profit – there is no limit to the success of this greed. It is by definition dependent on a majority of exploitable victims
By definition it is too hard for us to counter the exploitation of our inherent good nature. We accept the need for laws and a police force for protection from robbery and violence. The solution is to extend this protection against those who exploit our gullibility / good nature. The sooner we can return to this basic human trait and be proud of it, the better this world will be!
(*) eg. Why do people give money to obviously drunk or addicted beggars?
October 19, 2010 at 7:41 pm
Nugroho SBM
Thanks for Prof DC explanation. It made economics more realistic, so what Paul Ormerod said that Economics is dead is not true
October 21, 2010 at 2:29 am
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October 31, 2010 at 6:45 pm
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January 19, 2013 at 1:00 am
Larri
Absolutely need AirPlay.Why it matters: Dragging VGA/HDMI cabels all over the courtroom tends to piss off judges, bailiffs and clerks. Cables running across the floor create a tripping hazard for witnesses, attorneys and court personnel and you run the risk of jerking your projector and/or iPad off the table/podium. Cables cannot reach clear across a court room there is a limit to how far a cable can be run. Even if you can get long enough cabels, cabels are HEAVY and bulky adding unnecessary weight and girth to your already bulging tech bag. Finally, you cannot gracefully approach a witness on the stand and ask them to annotate while trailing a 25 foot VGA cable only to have the dongle fall out.A million reasons can be given why it might’ not work, or is difficult.’ But, the reality is that it is needed. Nine years ago, I approached an expert witness while carrying my Motion Tablet PC and had him mark up the exhibit in front of the jury wirelessly. The magical iPad should be able to match this functionality.Finally, FYI, there IS an iPad app that DOES display static images.