Al Roth, Matchmaker

Michael Giberson

Stanford’s alumni association magazine has a good article on recent economics Nobelist Al Roth. Several things about the article will trigger resistance among some free market readers, beginning with the title (“The Visible Hand”) and the subhead (A new breed of economist, Alvin Roth brings an engineering sensibility to fixing markets.). Deep into the article, this too: “Thanks to guys like Al Roth and powerful software … we were able to put all our incompatible pairs in there and just hit a button and the computer would spit out the answer.”

In fact just this morning I was just re-reading James Buchanan’s remarks about differences between economics as a science of allocation versus economics as a science of exchange – Buchanan was definitely in the exchange camp – and perhaps Buchanan would wonder whether or not these game-theoretic algorithms constituted a kind of applied economics or perhaps were something more akin to mere logistics tools. But in that article (“General Implications of Subjectivism in Economics”) Buchanan does suggest that game theory, in that it can frame situations from the point of view of economic agents, might constitute a valuable tool for understanding economics as a science of exchange.

But it is clear enough from the Stanford Magazine article that more than logistics is going on in Roth’s efforts. In all of the matching schemes Roth has helped develop, the incentives created for participants are a key constraint. It isn’t a mere matter of minimizing fuels costs for a delivery fleet, Roth is using economics to meddle with the rules of particular kinds of economic systems in order to bring about better arrangements as valued by the participants themselves. These efforts are not about imposing allocations, they are about enabling better exchanges in complex environments.

[HT to Daniel Cole, who draws attention to the dwarf-tossing issues raised at the end of the article.]


Game-industry market design job openings for economists

Michael Giberson

Buzzfeed columnist Russell Brandom explains, “Economists Are Taking Over the Game Industry: The game industry is hiring a new class of central bankers — but not in time to save Diablo III.” The post links to my earlier post on Diablo’s auction market design.

Perhaps in support of Brandom’s title, the current (June 2012) Job Openings for Economists, published by the American Economics Association, contains an advertisement from fiveoneninegames seeking a “Director of Monetization” to help the game company “develop and refine in-game economies” and “[help] decide how the virtual economies are structured and optimized in every mobile and web social game.”

Poor market design causing high prices in Diablo III auction house?

Michael Giberson 

I don’t play Diablo III, but I do follow price gouging discussions online, which led me to this post on the Diablo III discussion forum: “Auction House and Price Gouging.”

The initial complaint comes from a player trying to equip a new character through purchases in the Auction House, an in-game player-to-player trading mechanism, and finding prices were much higher than just a few weeks earlier.

WTF is going on? When I first got this game (release), I thought (despite all the issues) that the Auction House was a wonderful implementation …

I was able to gear up my Monk even at lower levels for fairly cheap. You have to remember that it was my first character and gold was scarce/difficult to come by, but still.. items in the AH were affordable. This includes +dex rares, IAS blues, +vit rares, etc.

3 weeks later and I finally roll another toon, only to find out that low level items (even in the 5-10 lvl range) are BEYOND inflated. I couldn’t even find blue +movement speed boots for my new DH without dropping 3-5k gold…

It seems like people price their gear (even low level gear) depending on what other people price their gear, so it almost feels like the sense of community (it’s difficult to explain, but I felt it in the beginning) has been replaced by $$$ signs, lol.

Price gouging leading to a loss of the sense of community? Sounds like someone has been reading his Michael Sandel.

Diablo III auction house screen shot from MMO News

A few economic explanations are offered in the replies, ranging from the basic microeconomics (“supply and demand”) to intermediate macroeconomics level (gold farmers are bringing too much money into the game, causing inflation).

The advanced economics explanations focuses on market design choices made by the game designers. Each player can only offer up to ten items at a time, and once offered the item cannot be replaced by another offer for 36 hours.

When the game was first released, many players were low level, no one had a lot of gold, and low-powered items were placed into the market as characters advanced and obtained better quality items. As characters became even more advanced, continuing to accumulate a mix of low-, medium-, and high-quality items, the 10-item limit becomes binding.

Now, to sell a low-quality item of the sort a beginning character could use, the player has to forego the opportunity to sell medium- or high-quality items at higher prices.

The opportunity cost of selling low-level items has risen, and the price follows.

NOTE: Diablo III will soon feature a real money Auction House.

NEWER, RELATED: Game-industry market design job openings for economists.

Market design helps people attain goals effectively

Michael Giberson

Harvard economic systems designer Al Roth is profiled in the Boston Globe:

Academically speaking, Roth is a pioneer of so-called market design: finding situations where a market is failing — often, a place that most people wouldn’t even recognize as a market — and making it work better. Roth has influenced a cadre of young, energetic market designers, many of whom have taken up prominent positions at top universities. Inspired by Roth’s work, these rising economists are also setting their sights on real-world problems. Some are looking at dating websites; others are interested in how universities could do better at scheduling their students’ classes. Like Roth, all of them envision a world in which economists, as unlikely as it may seem, are recognized as society’s mechanics.

Some market-oriented people will react negatively to the idea of “economists … as society’s mechanics,” but the negative reaction is based on a misunderstanding. Roth is no central planner. The point is to rework organizations so that participants in those organizations can more effectively achieve their goals.

When most people think of economics, they think of money — the study of how much things cost and why. Roth distinguishes himself by being more interested in situations where money plays little or no role — for instance, the process that determines who among the thousands of patients awaiting kidney transplants nationwide should receive the small number of organs that are available. As a society, we’ve decided we’re not comfortable with people selling their organs, so some other system — some other kind of market — is required. And a market, in Roth’s view, does not necessarily come down to prices, nor is it always ruled by simple principles like supply and demand: As long as people are competing with each other to get what they want, then resources are being allocated, and that means economists should be thinking about it.

One response to the lack of markets for transplantable kidneys is to agitate for change, to advocate lifting the regulations that prevent it. (Same for bone marrow.) These are good ideas. While we wait for society to get over its squeamishness at allowing compensation to donors, Roth’s kidney exchange is enabling more people to obtain transplants now. And Roth’s work on repugnance in markets is helping probe the reasons many people are reluctant to let markets work in this realm, so useful to advocates for change.

A by-product of working in areas where money plays little or no role is becoming sensitized to the role that money plays when it is allowed:

The trouble is that when you can’t rely on prices to stand in for value, things get complicated. In typical markets, “Money finds the matches,” said Utku Ünver, an associate professor of economics at Boston College who has collaborated with Roth on projects. “But when there’s no money, there’s lots of friction, and there are lots of things that may cause these markets to fail and not function efficiently.”

When you can’t use prices to express how much something’s worth, in other words, figuring out who should get what becomes a complicated business. “That’ll kill your economics 101 market real quick,” said [MIT economist Robert] Gibbons. “Al comes along to help you with situations where you’re not allowed to use the price mechanism.”


Rob Harmon at TEDxRanier: How the market can keep streams flowing

Michael Giberson

Rob Harmon gave a TEDx talk last fall in Seattle on a market mechanism that links willing buyers and willing sellers in a way that protects in-stream water flows and helps restore stream ecosystems. Harmon was formerly with the Bonneville Environmental Foundation (BEF) in Portland, Oregon, where he was a developer of the Water Restoration Certificates program.

The TED talk was just posted on the TED website, but a little searching around reveals that the smart water/markets/environment people were already aware. TEDx had the video up on youtube a few months ago, as Shawn Regan of PERC noticed in December.

In December 2009, David Zetland interviewed Rob Harmon about the program. [Zetland comments at Aguanomics; Link to MP3 audio.]

Here is bit from the Zetland interview beginning just after the 9:00 minute mark, where Harmon describes his visit to a stream that would have been dry in August but for the water restoration certificate program:

So, I decided this is a nice view from the bridge – you get the long view, you can see for a ways, you get the beaver dam.

But let’s go down and look right at the water. I walk down and I brought my camera with me and I looked in the water and I saw movement. And a stared and I stared and I stared, and I suddenly focused at the right depth and there were hundreds of baby steelheads. […]

Ordinarily, for the last ten, twenty, fifty years there would be no water for them to hatch into, they’d just die. […]

So, basically, here is habitat for all of these fish that ordinarily would not have habitat. It was a very sort of , it was a very sort of rubber meets the road sort of experience for me, sort of fish meet the water.

It went from the process, for me, of writing the contract, putting a business plan together, figuring out the website and the water calculator there on the website, and all of the things you do to make a business like this work, to actually seeing the results right before my eyes. That was very fulfilling, really nice to see actual ecological benefits right in front of me. (Unofficial transcript, parts edited out, use at your own risk.)

See also Harmon’s blog post about his trip to this site.

An interesting element here is that no laws needed to be changed to allow the program to work. The program works with the existing water laws in Oregon, Washington, and Montana. But for decades that law had led to regulation, extensive litigation, and dry stream beds because owners of water rights had to use their water rights in order to preserve them, and using involved withdrawing the water from the stream.

Until this program came along, there was no mechanism to allow water rights holders to use their rights to preserve in-stream flows. BEF does the necessary legwork: identifying streams at risk, tracking water flows, issuing certificates, and so on all the way up to bringing together willing buyers and willing sellers.

ASIDE: Next time a misguided free-market economist tells me markets can’t be designed, they can only emerge spontaneously, I am going to point to this example.

Would granting futures exchanges copyright protection for prices deter some market manipulation?

Michael Giberson

In New York Mercantile Exchange Inc. v. IntercontinentalExchange Inc., the U.S. Court of Appeals, Second Circuit denied NYMEX copyright protection for its settlement prices. The decision turned on application of the merger doctrine in copyright law, which governs cases in which the expression of an idea is so completely linked to the idea itself that granting copyright protection to an author’s work would in effect grant copyright protection to the idea expressed. Since ideas are not copyrightable, when a particular expression of an idea is so closely bound to the idea itself then the expression also cannot be copyrighted.

Jeremy Murray analyzes the court’s decision in a Buffalo Law Review piece, “The Death of Copyright Protection in Individual Price Valuations, a Flawed Merger Doctrine, and Financial Market Manipulation.” There is a lot of information here, some of which I only skimmed through, but Murray offers some interesting points on the link between copyright protection for exchange settlement prices and market manipulation exercises such as that of Amaranth Advisors.

In particular, he advises that ICE’s capability to directly link its product prices to NYMEX settlement prices created conditions in which the natural gas market manipulations by a Amaranth trader could flourish (if only for a short time). Among other things, Amaranth sought to profit by holding large short positions in natural gas on ICE, then drive the NYMEX price down by dumping a small long position in the last few minutes of trading. Murray argues that if ICE was required to identify its own settlement prices, rather than copying NYMEX settlement prices, then Amaranth-style manipulations would fail: dumping contracts on one market would not automatically and exactly manipulate the price of the other.

Murray also offers some interesting speculation as to whether NYMEX would have been more successful had it pursued a claim based on “time sensitive information” rather than copyright.

(While I liked much of Murray’s analysis, to motivate his discussion of market manipulation he relies way to heavily on quotes from politician. Let’s just say I’m not willing to take the claims of Sens. Maria Cantwell and Richard Durbin as authorities on energy market operations, nor am I convinced that sharply increasing energy prices in 2007 and 2008 were due to rampant market manipulation. Thankfully, the discussion is mostly irrelevant to his broader analysis.)

NOTES: New York Mercantile Exchange Inc. v. IntercontinentalExchange Inc., 497 F.3d 109, 112 (2d Cir. 2007), cert. denied, 128 S. Ct. 1669 (2008).

We discussed the NYMEX case here earlier, see “What is a Price? The Courts Think They Know; The Courts are Wrong“. Also related is “Prices are information goods, and information wants to be expensive, because it’s so valuable” and “CFTC Holds Hearings on Oversight of Energy Trading.”

Several posts here discuss the Amaranth manipulation charges.

An example of ways poorly constructed markets can fail

Michael Giberson

From the Mim’s Bits column in the MIT Technology Review: “How Mechanical Turk is Broken
Why the world’s most famous outsourcing hub for tiny tasks is littered with spam and shoddy workmanship

Mechanical Turk (MTurk) is Amazon’s site for linking companies seeking small web-based tasks requiring at least a bit of human intelligence to anonymous piece-rate web workers. Panos Ipeirotis, a computer scientist at NYU’s Stern School of Business, both uses MTurk to do research and does research on the MTurk marketplace.  He’s concluded that MTurk’s market design suffers from a “market for lemons” problem: lack of a reputation system for sellers (i.e. workers) means buyers (i.e. employers) can’t tell if they are getting high quality or low quality effort. If prices in the market reflect the average effort, it will be too low to retain high quality sellers. As high quality sellers leave, the average quality will fall and the price with it.

The Mim’s Bits column concludes, “Without transparency and accountability — the core ingredients of what economists call signaling — the site will continue to function primarily as an object lesson in the ways that poorly constructed markets fail.”

There is more to MTurk than this, including ways buyers can try to detect effort quality in order to improve seller effort. For more insight check out A Computer Scientist in a Business School where Ipeirotis blogs his MTurk research. Ipeirotis has related papers on his university website.

RELATED: Harvard researchers John Horton, David Rand, and Richard Zeckhauser write about using MTurk to conduct online social science research. Horton has related papers on his university website. Here is Horton’s list of economics-relevant stories from The Onion.

Many more academic papers on MTurk, via the Social Science Research Network.

What market design can do for you

Michael Giberson

Medicare pays medical equipment suppliers based on indexed-adjustments to a price list established 25 years ago. It is extremely unlikely that these prices are efficient. For the past 10 years Medicare has explored the possibility of pricing medical equipment via procurement auctions. Their procurement auction plan is fatally flawed.

What can market design do for you? Market design – that branch of economics that seeks to apply economic understanding to the task of creating or repairing markets – helps explain why the Medicare procurement plan will work badly and what can be done to enable it to work well.

At Freakonomics, Ian Ayres presents an op-ed co-written with Peter Cramton, “Fix Medicare’s Bizarre Auction Program,” that lays out two of the fatal flaws with the Medicare auction plan. The op-ed links to a brief analysis by Cramton and Brett Katzman of the issue.

(An overview prepared by staff of the U.S. House Energy and Commerce subcommittee describes the background and current state of Medicare’s payment system. Perhaps surprisingly, even the fatally flawed procurement auctions have produced cost savings of up to 56 percent on certain medical supplies, but that is more a measure of how bad the current method is rather than a recommendation of the proposed procurement auction.)

NHL’s experiments in hockey

Michael Giberson

Stephen Dubner at Freakonomics points to a Macleans story on some wild experimentation going on in the National Hockey League: shallower nets, moving the second referee off the ice, moving the face-off circles, three-on-three and two-on-two shootouts, and more. The article said:

The unusual nature of some items tested at the camp reminded Simon Fraser University business professor Lindsay Meredith of the freewheeling “skunk works” divisions that tech companies create to investigate advanced projects. “Any major corporation should have some kind of skunk works—a bank, a university, whatever,” he says. “An enterprise of that size and sophistication would be foolish not to.”

FIFA, you listening?

(Related: an April 2009 story in the Financial Times about an “experiments in business” course taught by Freakonomics co-author Steve Leavitt and John List at the University of Chicago.)

Cocoa market manipulation? The evidence suggests…

Michael Giberson

yes: cocoa market manipulation says Craig Pirrong.  He comes to that conclusion after his examination of price movements in cocoa markets revealed all the fingerprints of a classic squeeze.

In brief, Pirrong compared July London cocoa prices against September and November London prices and July New York prices over a period from January 2000 to June 2010. Anomalous moves in the July London price relative to these related markets suggest manipulation.  When Pirrong’s analysis is combined with one large trader seeking delivery on an unusually large percentage of July London contracts the case is more or less obvious.

Pirrong refers to his 2004 American Law and Economics Review article on the Ferruzzi soybean market episode for background on commodity market manipulation and its detection. For a more generally accessible explanation see his discussion in his recent Energy Law Journal article, “Energy Market Manipulation: Definition, Diagnosis, and Deterrence.” (The directly relevant explanation is in Section VI of the paper, but if you are interested in market manipulation then the entire paper is worth reading.)

See also Pirrong’s related recent blog posts: “Chocolate Kisses” and “Get a Room.”