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June 24 - July 17, 2018
Economics is about the efficient allocation of scarce resources, and about making resources less scarce.
A market involves matching whenever price isn’t the only determinant of who gets what.
Most markets and marketplaces operate in the substantial space between Adam Smith’s invisible hand and Chairman Mao’s five-year plans. Markets differ from central planning because no one but the participants themselves determines who gets what. And marketplaces differ from anything-goes laissez-faire because participants enter the marketplace knowing that it has rules.
The first task of a successful marketplace is bringing together many participants who want to transact, so they can seek out the best transactions. Having a lot of participants makes a market thick.
Congestion is a problem that marketplaces can face once they’ve achieved thickness.
Just as women can have more messages than they can answer, employers can have more applicants than they can interview. In both cases, congestion has set in, and that can make it impossible for participants to identify the most promising alternatives the market has to offer.
Decisions that depend on what others are doing are called strategic decisions and are the concern of the branch of economics called game theory.
For example, you probably don’t know where your bread was baked — but even if you do, your baker doesn’t have to know who grew the wheat that went into the flour used to make the bread. That’s because wheat is traded as a commodity — that is, it is bought and sold in batches that can all basically be considered the same.
The Chicago Board of Trade made wheat into a commodity by classifying it on the basis of its quality (number 1 being the best) and type (winter or spring, hard or soft, red or white). This meant that the railroads could mix wheat of the same grade and type instead of keeping each farmer’s crop segregated during shipping. It also meant that over time, buyers would learn to rely on the grading system and buy their wheat without having to inspect it first and to know whom they were buying it from.
Turning a market into a commodity market helps make it really thick, because any buyer can buy from any seller, and any seller can sell to any buyer. At the same time, it also helps the market deal with one of the main sources of congestion in matching markets, since in a commodity market each offer to sell can be made to all buyers, and each offer to buy can be made to all sellers. So unlike in the market for jobs, or for houses, no one has to wait for an offer to be made to him personally;
Notice the tension between commoditization and product differentiation — that is, between wanting to sell in a thick market to buyers even if they don’t care who you are, and trying to make your product special enough that many buyers will care enough about you to seek you out. Sellers enjoy selling in a thick market of buyers, but they don’t enjoy being interchangeable with other sellers.
Credit cards offered merchants safety, but that safety came at the cost of transaction fees. Most merchants were willing to pay those fees because accepting credit cards brought in customers they might otherwise have missed, and also because credit cards made it safe for them to take noncash payment from customers they didn’t know well, since the bank guaranteed payment as a form of insurance.
So the cards that were most popular became the most useful ones to carry and to accept, since they gave access to the thickest markets — that is, to the most restaurants and shops on one side, and the most diners and buyers of other goods and services on the other.
One thing we’ll see is that the “magic” of the market doesn’t happen by magic: many marketplaces fail to work well because of poor design. They may fail to make the market thick or safe, or to deal with congestion, and so there’s an opportunity to help them work better.
market design has to solve problems related to incentives, thickness, congestion, and timing, and how some kinds of transactions can be widely seen as repugnant.
markets and marketplaces come in many forms, some of which don’t conform to conventional notions of markets, and some in which money may play little or no role.
Withholding easy-to-match exchanges is a common temptation in markets with middlemen. Think about the market for real estate. When the market is hot, easy-to-sell homes may never appear on the market at all. Instead, real estate brokers will match sellers who list with them and who aren’t asking too high a price with buyers who come to them for help buying a home and don’t need to sell their own home before they can buy one.
We could track how many easy-to-match pairs each hospital enrolls. Then, whenever there was a tie between two hard-to-match pairs about which should be included in some exchange, it would be broken in favor of the pair with a patient from whichever hospital had enrolled easy-to-match-pairs, too.
Kidney exchange is very different from the markets we saw in chapter 2. But as I’ve tried to show, market design for kidney exchange is still about making the market thick, uncongested, safe and simple, and efficient.
In the next four chapters, we’ll look at failures — of thickness, congestion, and safety and simplicity. Then we’ll be in a better position to understand how some markets that were broken were able to be redesigned and repaired.
They become thin when too many participants try to transact before their competitors are fully awake and present in the market.
Exploding offers are common in unraveled markets. These offers are both early and short-lived. So not only are firms making offers before they have as much information as they’d like about how candidates might perform in school, but the candidates themselves are confronted with accepting or rejecting an offer before they know what other offers might become available. To put it another way, exploding offers make markets thin as well as early, and so participants are deprived of information about both the quality of matches and what kind of matches the market might offer. In that situation,
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In developing countries, it isn’t unusual to find marriages arranged quite early, particularly for women, and particularly in places where women are in short supply because men compete for multiple wives.
Postponing marriage when there is still a thick market in the future isn’t so risky, and more-mature brides and grooms might have a better chance of recognizing a good match. So the timing of transactions depends not just on what is available now, but what is likely to be available later.
Without a good market design, individual participants may still find it profitable to go a little early and engage in a kind of claim jumping. That’s why self-control is not a solution: you can control only yourself, and if others jump ahead of you, it might be in your self-interest to respond in kind. These early movers become the equivalent of the Sooners in the Oklahoma Land Rush.
As we’ll see in the next chapter, making the market operate within a narrow time frame — but without providing something, such as a clearinghouse, that brings order to the market at that time — usually isn’t a good enough solution to the problem of unraveling. It can cause congestion, as when members of an unruly crowd all try to stake their claims at the same time — which can result in a different kind of market failure, when people feel pressed to make offers (and demand replies) too fast rather than too soon.
BEING TOO EARLY isn’t the only way speed can prevent markets from achieving the thickness they need to succeed. Markets can also move too fast.
not everyone likes everything about a thick market. Buyers typically like to choose among many sellers, and sellers like to see lots of buyers. But those same buyers don’t want a bunch of other eager buyers driving up prices, and sellers hate that competitors might deprive them of a sale.
trades are made via a continuous electronic limit order book, which records the offers to buy (bids) and the offers to sell (asks) starting with the highest bid first and the lowest ask first. Anyone can sell or buy at any time by accepting the best bid or ask for x units of the financial commodity being traded.
I mention this because part of market design involves recognizing that good ideas may not be enough on their own to fix a market. It’s often also necessary to gather broad support from participants to get those ideas adopted and implemented. So it isn’t just a matter of good guys and bad guys. The interests of a wide range of participants must be taken into account to make sure that a new market design benefits as many people as possible.
by controlling the time at which offers are made, they make the market thick, but they haven’t given the participants any tools to deal with congestion. Consequently, exploding offers that are open only for a shockingly short time have remained very common.
Before participants can enjoy the benefits of a thick market, a marketplace has to overcome the congestion that thick markets bring with them — that is, the problem of how to allow multiple offers to be made and considered in the time available. We turn next to consider this problem of congestion.
Surprisingly, markets can be too slow, or congested, even on the Internet. Although the Net operates at the speed of computers, the people using it still need time to consider and act. That’s why, if you really want to operate at digital speeds, you need to take people out of the middle of the process.
Thus smartphones make the home hosting market work better not just because hosts can respond faster but also because they can update their bookings, which makes them more informative. This, too, reduces congestion (fewer rooms appear to be available, and a room that looks available is more likely to actually be so), and as a result helps travelers search more efficiently, with fewer time-wasting false leads.
Limousines have been around for a long time, and there have always been spare bedrooms that you could arrange to rent through friends. But computers and smartphones have helped Uber and Airbnb build multibillion-dollar businesses by making those markets thicker and quicker, bigger and less congested.
How about the tickets you bought for a game or a show that you can no longer attend — or tickets that you really want but are sold out? StubHub is now making a market for those tickets. In 2007, StubHub was acquired by eBay,
(By the way, speed is becoming important to eBay, too. Whereas most items were originally sold by auction, today most are sold at a fixed price. That’s a faster way to do business, because you can buy what you want as soon as you want it, without having to wait for an auction to end — and taking the chance of losing and having to try again in another auction.)
how to make the market thick by attracting lots of buyers and sellers; how to overcome the potential congestion that could result — that is, how to make the market quick even when it was thick; and how to make the market safe and trustworthy (we’ll return to this later).
Congestion threatened the very thickness of the market that makes them both big businesses.
Thick markets need to be quick, but it’s hard to be quick — no matter how fast the technology — if people have to wait for other people to make and act on their decisions.
So for a marketplace to be truly trustworthy, it must be safe; participants on both sides of a transaction must be able to rely on each other and on the technology.
Up to this point, market designs for trustworthiness have focused on providing secure methods to make payments, providing insurance for transactions that go bad, and building feedback systems that allow reliable sellers, and sometimes buyers, to develop and display good reputations.
only the winning bidder and the seller could leave feedback about each other. That way, ratings couldn’t be easily distorted by “feedback stuffing” from one individual.
Buyers and sellers were adhering to an unwritten rule of eBay culture: you scratch my back, and I’ll scratch yours. The result was that the vast majority of the feedback following a transaction was mutually positive, with just a smattering of mutually negative posts.
Markets depend on reliable information. In the case of reputation, buyers want reliable information about a seller, in the form of information about other buyers’ experiences. But if it is costly or risky for buyers to supply that information, they won’t do so, and the whole market will suffer.
When eBay made it safer to reveal dissatisfaction, the information about sellers became more detailed and useful.
Just as the Penicillium mold had evolved a way to deal with bacteria that could be adapted to fix a failure of human immune systems, ideas for correcting market failures can begin with an observation, “in the wild,” about ways in which other markets have been organized.
If a suggested matching isn’t stable — that is, if there exists at least one applicant and employer who aren’t matched to each other but would prefer to be — this unsatisfied pair is called a blocking pair. A matching is called unstable if there are any blocking pairs, since the members of a blocking pair can block the proposed unstable matching by instead making a match with each other.
The notion of stability wasn’t clearly formulated until ten years later, in a 1962 article by David Gale and Lloyd Shapley with the intriguing title “College Admissions and the Stability of Marriage.”
Gale and Shapley called their version the deferred acceptance algorithm, and it eventually became the most important strain of the Penicillium mold for fixing failed matching markets — not least because they recognized that it always produces a stable matching, at least for markets without too many complications, such as couples who need two jobs in the same city. (But I’m getting ahead of myself.)
