Advanced Microeconomics: design and study of markets

Objective

The objective of the course is to introduce students to recent developments and tools of microeconomics. We will do so by using, revisiting and extending the standard settings viewed so far in microeconomics. Our main objective is to make some progress on two fundamental questions in microeconomics:

1. Are markets efficient (even if consumers are not perfectly rational?)
2. How to design markets so as to achieve a desirable allocation of resources?

The first part of the course considers markets where consumers suffer from systematic misperceptions (or biased beliefs). We will first introduce the technical apparatus used to study misperceptions in microeconomics and use this framework to analyze empirical (and experimental) evidence on belief biases and their economic implications. We will then study some common markets where consumer misperceptions have been shown to play an important role. We will show how the answers to standard economic questions – the efficiency of market allocations, the effect of competition, the scope for public intervention – are affected by the existence and the nature of consumers’ misperceptions.

The second part of the course explores markets under a different perspective: how should we assign scarce resources? We will see how the tools viewed so far in microeconomics such as markets and game theory can be used and extended to practical assignment problems. We will investigate two different settings: one where we cannot use monetary transfers and one where we can use transfers. In each setting, we will follow the standard roadmap of the “economist as an engineer”:

1. Define the problem,
2. Define the matchings we find desirable,
3. Study the existence and the properties of such matchings,
4. Design mechanisms to find such matchings in practice and
5. Study the incentives of the agents facing these mechanisms.

Both settings will be illustrated by a typical application: school choice for matching without transfer and ad auctions for matching with transfers. We will also see how these applications have shaped new problems and led to new solutions.

Pre-requisite: The course heavily builds on the M1 MiE’s two Advanced Micro courses of S1 and S2 (M1 MiE). So a good knowledge of the Adv. Micro M1-S1 course is needed (decision theory, consumer problem, general equilibrium). Basics of Game Theory will also be needed (Adv. Micro M1-S2). The first part is also building upon some concepts viewed in Adv. Micro M2-S1. For the second part, knowing the basics of auctions is a plus but not necessary.

Evaluation method: A two hours sit in exam + one oral presentation of a research paper picked in a proposed list.

Planning

Two parts of 6*2h each: the first one by Yves Le Yaouanq and the second one by Julien Combe. The course being new, the plan given below is tentative and is subject to changes depending on the speed of the class.

Part I by Yves Le Yaouanq: Biased Beliefs: Individuals and Markets

Chapter 1 (3 sessions): Biased beliefs: theory, measurement and evidence (beyond Micro M2-M1)

• The Bayesian framework (properties of Bayesian updating, martingales, convergence theorems, experimentation, Blackwell experiments)
• Cognitive biases (heuristics a la Kahneman Tversky, overconfidence and optimism, motivated cognition)

Chapter 2 (3 sessions): Biased beliefs in the market (beyond Micro M1-S1)

• Shrouded attributes
• Time-inconsistency and naiveté
• Procrastination
• Overconfidence
• Inattention
• Contracting with behavioral agents
• The role of regulation

Part II by Julien Combe:  Market Design: the economist as an engineer

Chapter 1: What can be done without money? Matching without transfers

• The one-to-one two-sided matching framework, stable matchings, the Gale-Shapley algorithm, the structure of the set of stable matchings, core vs. stable matchings, strategic behavior, the many-to-one framework: similarities and differences, Rural Hospital Theorem

Chapter 2: School choice

• School choice as a two-sided matching problem, the Boston mechanism and its flaws, Pareto efficient v.s. stable matchings, the Top Trading Cycle Algorithm, analyzing school choice reforms

Chapter 3: What can be done with money? Matching with transfers

• The assignment game of Shapley-Shubik, feasible assignments, efficient assignments, pairwise stable assignments v.s. core assignments v.s. Walrasian equilibria, equivalence theorem of Shapley-Shubik, buyer and seller optimal assignments, the Vickrey Clark Groves (VCG) mechanism, strategic behavior, the continuum framework: a brief overview of optimal transport

Chapter 4: Auctions

• The model of Search Ads, Pay your bid auctions, the Generalized Second Price auction, GSP vs. VCG, efficient vs. revenue maximizing auctions, if time permitted: Myerson optimal auction design.

References

Part I

Heidhues and Köszegi (2018) “Behavioral industrial organization” Handbook of Behavioral Economics: Applications and Foundations 1 1 (2018): 517-612.

Köszegi (2014) “Behavioral contract theory” Journal of Economic Literature 52(4), 1075-1118.

Spiegler (2011) “Bounded rationality and industrial organization” Oxford University Press.

Part II

Some general non-technical references:

Roth (2002) "The economist as engineer: game theory, experimentation, and computation as tools for design economics," Econometrica, 4, 1341-1378.

Roth (2008) "The Deferred Acceptance Algorithms: History, Theory, Practice, and Open Questions," International Journal of Game Theory, 36, 537-569.

Paul Klemperer, Auctions: Theory and Practice, Princeton University Press (2004) [Part B & C], the book is available online at http://www.gqq10.dial.pipex.com/

Classic textbooks:

Roth and Sotomayor (1990) Two-Sided Matching: A Study in Game-Theoretic Modelling and Analysis, Econometric Society Monograph Series, Cambridge University Press. Chapters 1,2,4.

Haeringer, G. (2018). Market design: auctions and matching. MIT Press.

Vijay Krishna, Auction Theory, Academic Press (2002)

Milgrom, P., & Milgrom, P. R. (2004). Putting auction theory to work. Cambridge University Press.