IT WAS 5:00 a.m. on an April morning in 2010. Eight teams of surgeons were preparing to operate on eight patients in four different cities. Four healthy people would each be donating one of their kidneys to someone they had never met, and those four recipients, each suffering from end-stage renal disease, would receive a new lease on life.
At the same time, Jerry and Pamela Green were at their kitchen table in Lincoln, Massachusetts, studying the weather. They were soon to fly as volunteers, in their own small airplane, to Lebanon, New Hampshire, to pick up one of those kidneys, take it to Philadelphia, pick up another kidney there, and take it to Boston. (Two other pilots would transport the other two kidneys.) Because they identified their flight with the call sign “Lifeguard,” signifying medical urgency, the air traffic controllers would take them, no questions asked, right through one of the world’s busiest airspaces, down the Hudson River and over Newark airport, on their way to Philadelphia, where they would be scheduled to land immediately. Several jetliners carrying hundreds of passengers would be briefly delayed by their passage.
Kidneys for transplantation are scarce. So is airspace: an airliner uses several hundred dollars per minute in fuel, and only one airplane can occupy a given block of airspace at a time. Passengers’ time is also costly. Who got which kidney, which operating room, and which flight path that day in April all required an allocation of scarce resources, so it is perhaps fitting that when Jerry is not flying a small plane, he is a professor of economics at Harvard.
Economics is about the efficient allocation of scarce resources, and about making resources less scarce.
Those kidneys and flights weren’t the only scarce resources that had been allocated to bring everything together on that day when four lives were saved. Years earlier, each surgeon had been admitted to medical school and then had proceeded through surgical residencies and fellowships. At each stage, they’d competed with other aspiring physicians. Jerry himself had to go through a similar set of competitions to get his job. Before embarking on their professional training, Jerry and the surgeons had been admitted to colleges, and before that Jerry had been admitted to Stuyvesant, New York City’s most selective public high school. Notice that none of these things — kidneys, places in competitive schools, sought-after jobs — can be acquired by the person willing to pay the most or work for the lowest wage. In each case, a match must be made.
The Talmud tells of a rabbi who is asked what the Creator of the universe has been doing since the creation. The rabbi answers, “He has been making matches.” The story goes on to make clear why making matches — in this case, successful marriages — is not only important but also difficult, “as hard as dividing the Red Sea.”
Matching is economist-speak for how we get the many things we choose in life that also must choose us. You can’t just inform Yale University that you’re enrolling or Google that you’re showing up for work. You also have to be admitted or hired. Neither can Yale or Google dictate who will come to them, any more than one spouse can simply choose another: each also has to be chosen.
Often there is a structured matchmaking environment — some kind of application and selection process — through which that courtship and choosing takes place. Those matching processes, and how well we navigate them, determine some of the most important turning points in our lives, and many smaller ones, too. Matching dictates not only who gets admitted to the best colleges but also which students get into the most popular courses and which ones live in the best dorms. After college, it determines who lands the best jobs and who has the best opportunities for advancement. Matching sometimes is the gatekeeper of life itself, as when it determines which desperately ill patients receive scarce organs for transplant.
Even if matches are made in heaven, they are found in marketplaces. And markets, like love stories, begin with desires. Marketplaces help shape and satisfy those desires, bringing together buyers and sellers, students and teachers, job seekers and those looking to hire, and even sometimes those looking for love.
Until recently, economists often passed quickly over matching and focused primarily on commodity markets, in which prices alone determine who gets what. In a commodity market, you decide what you want, and if you can afford it, you get it. When buying one hundred shares of AT&T on the New York Stock Exchange, you needn’t worry about whether the seller will pick you. You don’t have to submit an application or engage in any kind of courtship. Likewise, the seller doesn’t have to pitch himself to you. The price does all the work, bringing the two of you together at the price at which supply equals demand. On the NYSE, the price decides who gets what.
But in matching markets, prices don’t work that way. Going to college can be costly, and not everyone can afford it. But that isn’t because colleges raise tuition until only as many students can afford to attend as the college can accommodate — that is, until demand equals supply. On the contrary, selective colleges, high priced as they are, try to keep the tuition low enough so that many students would like to attend, and then they admit a fraction of those who apply. And colleges can’t just choose their students; they have to woo them, too, offering tours, fancy facilities, financial aid, and scholarships, since many students are admitted to more than one school. Similarly, many employers don’t reduce wages until just enough desperate job hunters remain to fill their ranks. They want the most qualified and committed employees, not the cheapest ones. In the working world, courtship often goes both ways, with employers offering good salaries, perks, and prospects for advancement, and applicants signaling their passion, credentials, and drive. College admissions and labor markets are more than a little like courtship and marriage: each is a two-sided matching market that involves searching and wooing on both sides. A market involves matching whenever price isn’t the only determinant of who gets what.
Some matches don’t use money at all. Kidney transplants cost a lot, but cash doesn’t decide who gets a kidney. In fact, it’s illegal to buy or sell kidneys for transplantation. Similarly, airport landing slots involve fees, but that isn’t what determines who gets them. Access to public education also isn’t priced. Taxpayers support schools precisely so that every child can attend for free. Many people would find it repugnant to allow money to decide who gets a kidney or a seat in a sought-after public kindergarten. When there aren’t enough kidneys to go around (and there aren’t) or seats in the best public schools (there never are), scarce resources must be allocated by some kind of matching process.
Sometimes a matching process, whether formal or ad hoc, evolves over time. But sometimes, especially recently, it is designed. The new economics of market design brings science to matchmaking, and to markets generally. That’s what this book is about. Along with a handful of colleagues around the world, I’ve helped create the new discipline of market design. Market design helps solve problems that existing marketplaces haven’t been able to solve naturally. Our work gives us new insights into what really makes “free markets” free to work properly.
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.
Boxing was transformed from brawl to sport when John Douglas, the ninth Marquess of Queensberry, endorsed the rules that bear his name. The rules make the sport safe enough to attract competitors but don’t dictate the outcome. In just this way, marketplaces, from big ones like the New York Stock Exchange to little ones like a neighborhood farmers’ market, operate according to rules. And those rules, which are tweaked from time to time to make the market work better, are the market’s design. Design is a noun as well as a verb; even markets whose rules have evolved slowly have a design, although no one may have consciously designed them.
Internet marketplaces have very precise rules, because when a market is on the Web, its rules have to be formalized in software. And now that we can access the Internet from mobile devices, we’re never far from a market.
Markets are connected: Internet markets depend on the markets for radio spectrum that have allowed smartphones and other mobile access to flourish where only television and radio used to be.
I’ve helped design some of the markets and matching processes that I’ll introduce in this book. Almost all American doctors, for example, get their first jobs through a clearinghouse called the National Resident Matching Program. In the mid-1990s, I directed the redesign of the NRMP’s matchmaking algorithm, which today matches more than 20,000 young doctors with about 4,000 residency programs every year. My colleagues and I helped design matchmaking procedures for doctors later in their careers as well. We also helped design the current system for matching students to high schools in New York City (well after Jerry Green navigated that system) and for schools in Boston and other big cities. The exchanges that Jerry and Pam’s flights helped accomplish were arranged by the New England Program for Kidney Exchange (NEPKE), which sprang in part from a design I proposed with two economist colleagues, Utku Ünver and Tayfun Sönmez. In 2004, we helped a group of surgeons and other transplant experts found NEPKE, which used the algorithms we wrote to match donors and recipients, and since then we’ve helped our surgical colleagues make kidney exchange a standard part of transplantation.
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. Making a market thick takes different forms in different markets. To build clearinghouses for kidney exchange, for example, we first had to make the market thick by building databases of patients and donors.
Efforts to keep markets thick often concern the timing of transactions. When should offers be made? How long should they be left open? You can see that even in marketplaces for commodities, from a local farmers’ market to a stock exchange. The farmers’ market near my old home opens at a fixed time, and if you happen to come a bit early, vendors hesitate to sell you so much as a raspberry beforehand. If they did, they would incur the wrath of their fellow merchants, who worry that if some vendors started to sell before the market officially opened, some customers would come earlier, and an afternoon market could unravel to become an all-day market, requiring the vendors to spend more time selling in a “thinner” market. That’s more or less the same reason — to keep the market thick — that the New York Stock Exchange opens for business at the same time each day and closes just as punctually.
Congestion is a problem that marketplaces can face once they’ve achieved thickness. It’s the economic equivalent of a traffic jam, a curse of success. The range of options in a thick market can be overwhelming, and it may take time to evaluate a potential deal, or to consummate it. Marketplaces can help organize potential transactions so that they can be evaluated fast enough that if particular deals fall through, other opportunities will still be available. In commodity markets, price does this well, since a single offer can be made to the entire market (“Anyone can buy a pint of my raspberries for $5.50”), but in matching markets, each transaction may have to be considered separately, as in job markets, in which each candidate has to be evaluated individually.
Although it’s great to have a marketplace that gives you an abundance of opportunities, these may be illusory if you can’t evaluate them, and they can cause the market to lose much of its usefulness. Think of an Internet dating site on which women with appealing photos receive far more messages than they can answer and men find that very few of their messages draw responses. This causes men to send more, and hence more superficial, messages and women to respond to fewer and fewer of them. 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.
While buyers like to see many sellers, and sellers like to see multitudes of buyers, sellers aren’t so wild about competing with all those other sellers, nor are buyers necessarily glad to have such a crush of competition. So sometimes someone will try hard to transact before the marketplace opens, and in some of the labor markets we’ll see in this book, this has led to increasingly early offers or to increased insistence that the offers be answered immediately, before other offers can be entertained. It can be hard to determine when early “exploding” offers are meant to gain an advantage over potential competitors and when they are just attempts to deal with congestion (i.e., if there isn’t enough time to make enough offers, start early and move fast). In either case, early exploding offers dilute the thickness of the market and sometimes lead to big reorganizations, such as the development of the labor market clearinghouses for doctors.
One thing that all markets challenge participants to do is to decide what they like. Students have to consider which colleges will suit them, and colleges have to sort through thousands of applications. What often makes matching markets especially challenging is that everyone has to puzzle through not only their own desires but also those of everyone else and how all those other market participants might act to achieve their preferences. College admissions officers aren’t simply trying to pick the best students. They’re trying to pick the best students who will choose to attend if admitted (and this involves considering where else those students have applied and whom those competing colleges are likely to admit). And so students have to try to signal to colleges not only how good they are but also how interested they are. Should they apply, via binding early admission, to one school? If so, should they pick the school that they like best but that might be a long shot, or should they apply to a school that’s more likely to value their expression of commitment and admit them? In short, both students and colleges have to make decisions that depend a lot on those made by many other students and colleges. (As they say about football, everything is complicated by the presence of the other team!)
Decisions that depend on what others are doing are called strategic decisions and are the concern of the branch of economics called game theory. Strategic decision making plays a big role in determining who does well or badly in many selection processes. Often when we game theorists study a matching process, we learn how participants “game the system.” Well-designed matching processes try to take into account the fact that participants are making strategic decisions. Sometimes the goal of the market designer is to reduce the need to game the system, allowing choosers to concentrate on identifying their true needs and desires. Other times the goal is to ensure that even if some gaming is inevitable, the market can still work freely. A good marketplace makes participation safe and simple.
When a market doesn’t deal effectively with congestion and participants may not be able to find the transactions they want, it might not be safe for them to wait for the marketplace to open if some opportunities are available earlier. Even when going early isn’t an option, the marketplace might force participants to engage in risky gambles.
This was the issue that led Boston Public Schools to invite my colleagues and me to help redesign the system for matching children to schools. Under Boston’s old system, parents had to strategize about which school they named as their first choice, since the assignment rules made it difficult to get their child assigned to a good school if they didn’t list that school first. That wasn’t simple. The new system, in contrast, makes it safe for parents to list their true preferences and frees them to think about which schools they actually like best, without having to decide which one school they’re prepared to gamble on.
Every market has a story to tell. Stories about market design often begin with failure — failure to provide thickness, to ease congestion, or to make participation safe and simple. In many of the stories in this book, market designers are like firefighters who come to the rescue when a market has failed and try to redesign a marketplace, or design a new one, that will restore order.
But markets can succeed on their own practical terms and still fail in the eyes of those who don’t or won’t participate in them. Some markets are regarded as repugnant; these run the gamut from slavery to illegal drugs to prostitution. Kidney exchange arose in the shadow of laws around the world that criminalize buying and selling human organs for transplantation (despite which laws, black markets exist, some of which work very badly indeed).
Repugnant transactions — transactions that some people don’t want others to engage in — don’t have to involve money. Witness the debates on the status of same-sex marriage. But often the addition of money makes an otherwise acceptable transaction seem repugnant, which is why there are laws against selling kidneys but not against kidney exchange, and why consensual sex is generally acceptable but prostitution is generally not. Note, however, that in some places consensual sex (say, between unmarried partners) is considered repugnant. And in some places, prostitution is legal. Repugnance shows with particular clarity what all markets reveal: people’s values, desires, and beliefs.
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