We have a new guest-blogger:  Roger Myerson.

Roger is a game theorist but his work is known to everyone – theorist or otherwise – who has done graduate work in economics.  If an economist from the late nineteenth century, like Edgeworth, or early twentieth century, like Marshall, wakes up and asks, “What’s new in economics since my time?”, I guess one answer is, “Information Economics”.

Is the investment bank trying to sell me a security that it is trying to dump or is it a good investment?  Is a bank’s employee screening borrowers carefully before he makes mortgage loans? Does the insurance company have enough reserves to cover its policies if many of them go bad at the same time?  All these topical situations are characterized by asymmetric information: One party knows some information or is taking an action that is not observable to a trading partner.

While the classical economists certainly discussed information, they did not think about it systematically.  At the very least, we have to get into the nitty-gritty of how an economic agent’s allocation varies with his actions and his information to study the impact of asymmetric information.  And perfect competition with its focus on prices and quantities is not a natural paradigm for studying these kind of issues. But if we open the Pandora’s Box of production and exchange to study allocation systems broader than perfect competition, how are we even going to be able to sort through the infinite possibilities that appear?   And how are we going to determine the best way to deal with the constraints imposed by asymmetric information?

These questions were answered by the field of mechanism design to which Roger Myerson made major contributions.  If an allocation of resources is achievable by any allocation system (or mechanism), then it can be achieved by a “direct revelation game” DRG where agents are given the incentive to report their information honestly, told actions to take and then given the incentives to follow orders.  To get an agent to tell you his information, you may have to pay him “information rent”.  To get an agent to take an action, you may have to pay him a kind of bonus for performing well, “an efficiency wage”.  But these payments are unavoidable – if you have to pay them in a DRG, you have to pay them (or more!) in any other mechanism.  All this is quite abstract, but it has practical applications. Roger used these techniques to show that the kind of simple auctions we see in the real world in fact maximize expected profits for the seller in certain circumstances, even though they leave information rents to the winner.   These rents must be paid in a DRG and hence if an auction leaves exactly these rents to the buyers, the seller cannot do any better.

For this work and more, he won the Nobel Memorial Prize in Economics in 2007 with Leo Hurwicz and Eric Maskin.  Recently, Jeff mentioned that Roger and Mark Satterthwaite should get a second Nobel for the Myerson-Satterthwaite Theorem which identifies environments where it is impossible to achieve efficient allocations because agents have to be paid information rents to reveal their information honestly. This work also uses the framework and DRG I have described above.

Over time, Roger has become more of an “applied theorist”.  That is a fuzzy term that means different things to different people.  To me, it means that a researcher begins by looking at an issue in the world and writes down a model to understand it and say something interesting about it.  Roger now thinks about how to build a system of government from scratch or about the causes of the financial crisis.  How do we make sure leaders and their henchmen behave themselves and don’t try to extract more than minimum rents?  How can incentives of investment advisors generate credit cycles?

These questions are important and obviously motivated by political and economic events.  The first question belongs to “political economy” and hints at Roger’s interests in political science.  More broadly, Roger is now interested in all sorts of policy questions, in economics and domestic and foreign policy.

Jeff and I are very happy to have him as a guest blogger.  We hope he finds it easy and fun and the blog provides him with a path to get his analyses and opinions into the public domain.  We hope he becomes a permanent member of the blog.  So, if among the posts about masturbation and Charlie Sheen’s marital problems you find a post about “What should be done in Afghanistan”, you’ll know who wrote it.

Welcome Roger!