Market Design: Harnessing Market Methods to Improve Resource Allocation

Abstract

The emerging field of market design applies auctions and matching to solve resource allocation problems. This paper focuses on auction design, the branch of market design where money is used to facilitate the exchange of goods and services. Within auctions, the paper examines applications involving government regulated resources. Who should use the scarce radio spectrum and at what prices? How should electricity markets be organized? How should financial markets be regulated? And how should runway access be assigned at congested airports? All of these are important questions in major industries. Researchers in market design have made substantial progress in answering these questions over the last fifteen years. The efforts, although at the forefront of theory have been closely tied to practice, and involved interdisciplinary teams of economists, computer scientists, and engineers, all working to solve real problems. Despite this rapid progress, the field holds much promise to provide better answers in even more complex economic environments over the next two decades. The rewards to society from improved markets will be immense. As deficits grow and baby-boomers age, governments face increasing challenges in making the best use of public resources. One successful innovation to improve the allocation of scarce public resources is for the government to harness market methods to improve decision making. The spectrum auctions, conducted by the Federal Communications Commission (FCC) since 1994, are an excellent example. These auctions, which arose from a collaboration of scientists with auction expertise, industry, and the FCC, have led to over $100 billion in new non-distortionary U.S. government revenue, and more importantly, have put the scarce spectrum resource into the hands of those best able to use it. This innovation has been a win-win for taxpayers, the companies participating in the auctions, and the hundreds of millions now enjoying advanced wireless communications services. The auction program has been replicated worldwide and remains a key example of effective government, both in the U.S. and abroad (Milgrom 2004). The spectrum auction program stimulated key scientific innovations in our understanding of how to auction many related items. These innovations have been applied not just to spectrum auctions but to e-commerce, both public and private. The advances to date, while important, are only the tip of the iceberg. Tremendous opportunities lie ahead and will be realized in coming decades with further scientific advancement in auction design.