DEFINITION of Mechanism Design

Mechanism design is a branch of microeconomics that explores how businesses and institutions can achieve desirable social or economic outcomes given the constraints of individuals' self-interest and incomplete information.

BREAKING DOWN Mechanism Design

Mechanism design examines how entities can achieve their desired social or economic outcomes given the constraints on individuals' decision making abilities such as self-interest and incomplete information. When individuals act in their own self-interest, they may not be motivated to provide accurate information. Mechanism design takes private information and incentives into account to enhance economists' comprehension of market mechanisms and shows how the right incentives (money) can induce participants to reveal their private information and create an optimal outcome.

Leonid Hurwicz, Eric Maskin and Roger Myerson won the 2007 Nobel Prize in Economics for laying the foundations of mechanism design theory. One application of the theory, as shown by Myerson, is auction design. Mechanism design is also known as "reverse game theory" or "incentive-compatible mechanisms."