Revelation principle: encouraging truthful strategies

Les joueurs de cartes - Paul Cézanne - 1890-1892

Source : Goeree, Jacob K. and Kushnir, Alexey I., A Geometric Approach to Mechanism Design (December 20, 2011). University of Zurich Department of Economics Working Paper No. 56. Available at SSRN: http://ssrn.com/abstract=1974922 or http://dx.doi.org/10.2139/ssrn.1974922

Mechanism design is the science of creating optimal social systems by maximizing a well-defined social welfare function taking into account resource constraints and participants' incentives and hidden information. It provides a framework to address social engineering questions like what auction format assigns goods most efficiently or yields the highest seller revenue, “when should a public project such as building a highway be undertaken?” and “which trading rules maximize the gains from trade?”

The difficulty in answering these questions stems from the fact that the designer, or public authority, typically does not possess detailed information about the relevant parameters, e.g. bidders' valuations for the goods for sale or voters' preferences for the public project.

A well-designed mechanism should therefore both truthfully elicit participants' private information and implement the corresponding social optimum.

Hurwicz (1960) was among the first to recognize the prevalence and importance of economically relevant information that is dispersed in the population. He introduced a formal model of communication where agents send messages to a central planner who selects an outcome based on a pre-specified rule. Hurwicz (1972) also introduced the key notion of incentive compatibility, which emphasizes the need for collecting agents' private information in a manner that is coherent with their incentives. The study of incentive compatible mechanisms was significantly simplified through the observation of the revelation principle by Gibbard (1973) and subsequent extensions to incomplete information environments by Dasgupta, Hammond, and Maskin (1979) and Myerson (1979). This principle implies that general mechanisms or institutions can be analyzed through equivalent direct revelation mechanisms, where participants' only form of communication or action is the revelation of their private information.

Dasgupta, Patha S., Peter Hammond, and Eric Maskin (1979) « The Implementation of Social

Choice Rules: Some General Results on Incentive Compatibility, » Review of Economic

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Hurwicz, Leonard (1960) « Optimality and Informational E_ciency in Resource Allocation Processes, » in Mathematical Methods in the Social Sciences, K. J. Arrow et al., eds., Stanford University Press, Stanford, 27-46.

Hurwicz, Leonard (1972) « On Informationally Decentralized Systems, » in Decision and Organization, C. B. McGuire and R. Radner, eds., North-Holland, Amsterdam, 297-336.

Myerson, Roger B. (1981) « Optimal Auction Design, » Mathematics of Operations Research, 6, 58-73.