Mechanism Design Theory

Definition of 'Mechanism Design Theory'


An economic theory that seeks to determine the situations in which a particular strategy or mechanism will work efficiently, compared to situations in which the same strategy will not work as efficiently. Mechanism design theory allows economists to analyze and compare the way in which markets or institutions, such as a government, efficiently allocate goods and services given a gap in information between buyers and sellers.

An example of mechanism design theory would be of an auction in which sellers (who want a higher price for the auctioned item) and buyers (who want a lower one) compete to set the value of the transaction, and in which neither buyers or sellers possess all available information because some is held by only one party. Mechanism design theory seeks to identify where the various gaps in information will occur so that parties can avoid them.

Investopedia explains 'Mechanism Design Theory'


Unlike traditional game theory, in which variables concerning the goods and services produced, level of competition and extent of shared information are strictly controlled, mechanism design allows analysts more flexibility. Information about competitors in markets can be very limited, known as "information asymmetry."

Since mechanism design theory allows economists to relax restrictions on some variables, such as the importance of information control, it allows researchers to determine how different parties can benefit when a particular strategy is used in varying situations.



comments powered by Disqus
Hot Definitions
  1. Marginal Analysis

    An examination of the additional benefits of an activity compared to the additional costs of that activity. Companies use marginal analysis as a decision-making tool to help them maximize their profits. Individuals unconsciously use marginal analysis to make a host of everyday decisions. Marginal analysis is also widely used in microeconomics when analyzing how a complex system is affected by marginal manipulation of its comprising variables.
  2. Treasury Inflation Protected Securities - TIPS

    A treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the U.S. government and since their par value rises with inflation, as measured by the Consumer Price Index, while their interest rate remains fixed.
  3. Gilt-Edged Switching

    The selling and repurchasing of certain high-grade stocks or bonds to capture profits. Gilt-edged switching involves gilt-edged security, which can be high-grade stock or bond issued by a financially stable company such as the Blue Chip companies or by certain governments.
  4. Master Limited Partnership - MLP

    A type of limited partnership that is publicly traded. There are two types of partners in this type of partnership: The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the MLP's cash flow, whereas the general partner is the party responsible for managing the MLP's affairs and receives compensation that is linked to the performance of the venture.
  5. Class Action

    An action where an individual represents a group in a court claim. The judgment from the suit is for all the members of the group (class).
  6. Retail Sales

    An aggregated measure of the sales of retail goods over a stated time period, typically based on a data sampling that is extrapolated to model an entire country. In the U.S., the retail sales report is a monthly economic indicator compiled and released by the Census Bureau and the Department of Commerce.
Trading Center