Are you curious about how societal norms and repugnance shape markets? Want to know how market design can balance societal values and benefits? Did you ever wonder how speed can be a double-edged sword in markets, including high-speed trading and the recruitment of law clerks? Dive into the world of market design and its implications, from medical residencies to school admissions, and discover how to navigate the complexities of efficiently allocating scarce resources.

Who Gets What ― and Why: The New Economics of Matchmaking and Market Design

Early one April morning in 2010, eight surgical teams across four cities prepared to perform kidney transplants. Four donors would give their kidneys to four recipients they had never met, offering them a new lease on life. 

Jerry and Pamela Green, volunteers from Lincoln, Massachusetts, were ready to fly in their small plane to transport one of the kidneys. As they navigated busy airspace, their call sign “Lifeguard” ensured swift passage through one of the world’s busiest airspaces to deliver the kidneys in time. 

Economics, at its heart, is about the allocation of scarce resources, such as kidneys and airspace. This story underscores the importance of matchmaking in economics. Matching markets are not just about who pays the most, but about efficiently pairing needs and resources. This concept extends beyond commodities to more complex situations like college admissions and job markets.

The creation of kidney exchanges exemplifies this. Dr. Michael Rees, frustrated with the limitations of kidney transplants, pioneered the idea of kidney exchanges. By matching incompatible donor-patient pairs with others, more lives could be saved. This required a significant database and sophisticated algorithms to find compatible pairs.

Economists like Al and his colleagues played a crucial role in designing these algorithms. Their work, initially theoretical, became practical solutions for real-world problems. They created systems that allowed for safe, efficient exchanges, factoring in the complexities of human behavior and logistical challenges.

The New England Program for Kidney Exchange (NEPKE) and other similar initiatives showed the potential of these systems. Successful exchanges, such as a three-way exchange involving Dr. Andy Levey and his wife, demonstrated the life-changing impact of these designs. 

Altruistic donors further revolutionized kidney exchanges by starting chains of donations, exponentially increasing the number of transplants. Despite initial resistance, nonsimultaneous chains became accepted, proving highly effective.

The story of kidney exchanges highlights the complexities of market design, the interplay of incentives, and the importance of creating thick, uncongested, and safe markets. It also shows how understanding human behavior is crucial in designing effective markets. As markets evolve, continuous adjustments and learning from failures are essential for success.

Can Kidney Exchanges and Altruistic Donors Revolutionize Market Design?

Understanding how markets can fail involves examining various scenarios where timing and early decision-making lead to problematic outcomes. For instance, the recruitment process for college freshmen joining fraternities and sororities, known as "rush," has evolved to start earlier and earlier. Similarly, the Oklahoma Land Rush of 1889 saw people racing to claim land, with some even risking early entry despite severe penalties, earning the nickname "Sooners."

The same rush mentality affects modern markets, such as college football bowl games. For years, bowl games faced issues because teams were selected too early, often before the final season results were known, leading to mismatched games and unsatisfactory outcomes for fans. The introduction of the Bowl Championship Series (BCS) in 1998 improved the situation by ensuring the top-ranked teams played in a national championship game, determined later in the season.

This problem of early decision-making, or "unraveling," also impacts professional markets. Law firms and investment banks often hire candidates years in advance, leading to mismatches when the actual time for employment arrives. During the 2008 Great Recession, many law firms had to rescind or defer job offers made too early, highlighting the inefficiencies of this system.

Efforts to control unraveling include setting rules for timely decisions, as seen in the market for medical residencies and fellowships. For example, gastroenterology fellowships implemented a clearinghouse to match candidates and positions at a more suitable time, reducing the need for early, binding offers.

In other markets, like orthopedic surgery fellowships, cultural differences required different solutions. Here, sanctions on early offers helped organize the market better.

The challenge of early decision-making extends beyond professional markets to personal decisions, like marriage, and even to mundane choices, like finding a parking spot. The key to solving these issues often lies in creating well-designed markets that encourage timely and informed decision-making, ensuring better matches and outcomes for all participants.

From Sooners to Bowl Games: The Perils of Early Decision-Making

Speed can be a double-edged sword in markets, boosting efficiency or causing chaos. While speed helps quickly evaluate multiple transactions in thick markets, excessive speed can unravel them. Buyers and sellers love a thick market but dislike the competition it brings, which can drive up prices or snatch sales away. The race to be faster has transformed industries, notably in finance, where milliseconds matter.

Consider the Chicago Mercantile Exchange, where Eric Budish, a market designer, examines high-speed trading. His insights reveal how the quest for speed, driven by new technologies like faster cables, hasn't improved markets but rather worsened them. High-speed traders disrupt liquidity providers, forcing them to adjust spreads, increasing costs for ordinary investors and contributing to market instability, as seen in the 2010 "flash crash."

Budish proposes a simple fix: instead of continuous trading, run markets once per second. This would shift focus from speed to price, leveling the playing field and reducing unnecessary investments in speed. It’s like switching from a chaotic race for falling money to a fair auction.

This issue isn't limited to finance. The hiring of law clerks in the U.S. courts shows how speed can lead to unraveling. Judges tried to set hiring deadlines, yet offers became "exploding," forcing students to decide quickly, often without exploring all options. Despite multiple attempts to regulate, the market kept unraveling due to congestion and strategic timing by judges.

Similarly, in Japan, companies circumvented recruitment rules by making unofficial offers, trapping graduates with slow-motion exploding offers. This practice limited choices and stifled market thickness.

Speed can be beneficial, as history shows with the telegraph's impact on the 19th-century cotton market. It reduced price volatility by speeding up information flow. However, modern markets need to balance speed with fairness, ensuring competition focuses on value, not just velocity.

Is Eric Budish's Market Design the Cure for High-Speed Trading Chaos?

Markets need to find a balance between being too fast or too slow, much like the Goldilocks principle. Too-fast transactions can be detrimental, but excessively slow transactions can also cause harm, even on the Internet. 

For instance, Airbnb faced challenges when it started because communication was slower as most users relied on computers. Travelers often had to wait a whole day to confirm a booking. As Airbnb grew, it had to compete with hotel chains that offered speedy confirmations. The advent of smartphones helped Airbnb close the speed gap, allowing hosts to manage reservations on-the-go and update availability immediately, which reduced congestion and made the booking process smoother.

Similarly, Uber transformed the limo and private car market by leveraging smartphones, making it as easy to call a limo as it was to hail a taxi. These innovations are examples of how markets can thrive by making transactions quicker and more efficient.

The story of New York City’s school system also highlights the importance of reducing congestion. The old paper-based system was slow and inefficient, causing many students to be assigned to schools at the last minute. By moving to a computerized system where preferences were submitted in advance, the process became faster and more efficient.

In Boston, although the school assignment system was computerized and appeared to work well, it was not trustworthy. Parents had to strategize to get their children into desirable schools, often listing less-preferred schools as their first choice to avoid ending up in an unpopular school. This strategic behavior indicated a lack of trust in the system. By redesigning the school choice system to make it safer for parents to reveal their true preferences, Boston was able to create a fairer and more effective process.

These examples show that for markets to be successful, they need to be quick, trustworthy, and safe for participants. Whether it’s booking a room, calling a car, or assigning school places, the right market design can make all the difference.

How Airbnb, Uber, and School Systems Mastered the Goldilocks Principle

Market design often involves both invention and discovery, much like the evolution of antibiotics with penicillin. Alexander Fleming's discovery in 1928 of penicillin from mold led to a revolution in medicine after further development by others. Similarly, solutions to market failures can emerge from observing other markets.

Consider the market for new doctors. Before 1900, doctors began practicing medicine immediately after graduation. However, by the 20th century, residency became a requirement, leading to fierce competition among hospitals for interns. This led to "unraveling," where hospitals made offers earlier and earlier, sometimes two years before graduation, creating mismatches and chaos.

By 1945, medical schools intervened, delaying the release of student information until a specific date. This helped but led to another issue: hospitals had to make "exploding offers," demanding immediate decisions from candidates, which congested the market.

In response, doctors devised a centralized system—a clearinghouse. Medical students and residency programs submitted ranked lists of preferences. The clearinghouse processed these lists to suggest stable matches, avoiding blocking pairs where both a student and a program preferred each other but weren’t matched. This system, introduced in 1952, became known as "the Match" and stabilized the market.

However, the rise of women in medicine introduced new complexities, particularly for couples seeking positions in the same location. This led to a redesign of the Match in the 1990s by economist Al Roth and Elliott Peranson, who created the Roth-Peranson algorithm. This algorithm handled complex preferences, including couples, making the Match more robust.

The Match demonstrates the power of centralized marketplaces over central planning. It balances the competitive nature of the market with the need for stability, showing that while markets can be designed to encourage participation and reveal true preferences, they have limits.

Next, the principles applied in the Match are extended to school choice systems, aiming to match children to schools based on family preferences, without monetary transactions. This is crucial in a democracy that values free and compulsory education, striving to provide quality education tailored to diverse needs.

Can We Thank Alexander Fleming and Al Roth for Transforming Medicine and Markets?

In 2003, Al Roth received a call from the New York City Department of Education, echoing a similar one from 1995 about redesigning the medical Match. This time, the issue was the city's failing high school choice system. The old paper-based system was congested and risky for students to reveal their true preferences. 

Principals held back seats for preferred students, creating a black market and leaving 30,000 students unassigned annually. Roth's team—Parag Pathak, Atila Abdulkadiroğlu—discovered that while student numbers matched school places, 17,000 students received multiple offers, jamming the system.

They proposed a single-offer system using the deferred acceptance algorithm, similar to the medical Match. Students could safely list schools in true order of preference without losing out. Principals would reveal all seats, assured they'd like their assigned students. 

The new system's first year saw unmatched students drop from 30,000 to 3,000, and more students got their top choices. Principals' confidence in the system grew, releasing more saved seats. Neil Dorosin, DOE's director, played a crucial role in educating everyone, including Chancellor Joel Klein, about the system's design.

Their success in New York led to similar projects in Boston and beyond. Boston switched to a deferred acceptance system, allowing families to list true preferences without losing priority. The Wu family in Dorchester successfully navigated this system, leading to a satisfying school placement for their daughter.

Other cities and countries sought their expertise, recognizing that well-designed school choice systems could improve educational opportunities despite not addressing the root issue of insufficient good schools. School choice can't solve inequality but helps use existing resources better. 

This experience taught them the value of markets that encourage honest communication, a lesson echoed in various fields, from job applications to online dating. As technology advances, distinguishing genuine signals from noise becomes crucial for efficient markets.

Transforming NYC Education: A Nobel-Winning Algorithm Reshapes School Choice

In California, it's illegal to sell horsemeat for human consumption, as per a law enacted in 1998. This isn't about safety or humane treatment of animals, but rather a societal repugnance towards eating horses, which many Californians find objectionable despite it being a delicacy in other parts of the world. 

Repugnance, as defined, is when some people want to engage in a transaction that others find morally or culturally unacceptable. This concept is evident in various historical and current contexts, such as Prohibition in the United States, which banned alcohol sales from 1920 to 1933 but led to black markets and organized crime, ultimately failing to uphold its moral objectives.

Repugnance is subjective and can change over time. For example, same-sex marriage, once widely opposed, has gained acceptance in many parts of the U.S. Similarly, polygamy, now illegal in the U.S., was historically accepted and still is in some cultures. Another example is the changing attitudes towards lending money with interest, once forbidden by the church but now a cornerstone of the global economy.

Some transactions, like selling kidneys, remain repugnant and illegal due to concerns about exploitation and human dignity, despite the potential to save lives. Black markets for kidneys highlight the dangers of unregulated transactions, yet the legal market in Iran offers insights into how such markets might be designed to address ethical concerns.

Market design can help navigate the complexities of repugnant transactions, aiming to balance benefits and societal values. For instance, kidney exchange programs have successfully increased transplants without cash payments. Expanding these exchanges globally could further alleviate shortages and reduce illegal trade.

In short, markets are human constructs shaped by societal norms and values. Understanding and respecting repugnance is crucial in designing markets that can adapt to changing attitudes while addressing ethical concerns and improving welfare.

Is Repugnance Shaping Our Markets: What Can We Learn from California's Horsemeat Ban?

Economics and market design are fundamentally about efficiently allocating scarce resources, which can range from kidneys to airspace. This is where matchmaking becomes crucial, ensuring that needs and resources are paired effectively. The concept of kidney exchanges is a prime example of this. By using sophisticated algorithms and databases, economists have helped design systems that facilitate efficient and lifesaving kidney transplants.

Market design isn’t just theoretical; it has practical implications in various fields, from medical residencies to school admissions. The success of markets often hinges on making them thick, uncongested, and safe. Speed is a critical factor, but it must be balanced; too much haste can cause chaos, while excessive delay can hinder progress.

Managing the timing of decisions is another challenge. Early decision-making, or "unraveling," can lead to mismatches and inefficiencies, as seen in professional hiring practices and college football bowl games. Solutions like setting rules for timely decisions and creating centralized systems have been employed to address these issues.

Moreover, designing trustworthy and efficient markets requires continuous adjustments and learning from failures. This involves understanding human behavior and creating environments that encourage honest communication. The balance of speed and fairness is key, ensuring markets function well without undue competition or congestion.

The idea of repugnance also plays a role in market design, highlighting that societal norms and values influence what transactions are deemed acceptable. Understanding and respecting these feelings is crucial for designing markets that are ethical and effective. This insight is evident in various historical and contemporary contexts, such as the changing attitudes toward same-sex marriage and the ongoing debate over selling kidneys.

Overall, well-designed markets can improve resource allocation, increase efficiency, and enhance welfare, but they must be adaptable and responsive to societal values and ethical considerations.

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Who Gets What ― and Why: The New Economics of Matchmaking and Market Design

Alvin E. Roth

Are you curious about how societal norms and repugnance shape markets?

Want to know how market design can balance societal values and benefits?

Did you ever wonder how speed can be a double-edged sword in markets, including high-speed trading and the recruitment of law clerks?

Dive into the world of market design and its implications, from medical residencies to school admissions, and discover how to navigate the complexities of efficiently allocating scarce resources.

Key Ideas

#1