Incentive Compatibility

Incentive Compatibility – along with mechanism design – is one of the key ideas for which the 2007 Nobel Prize in Economic Sciences was awarded. A mechanism is said to be incentive-compatible if every participant can achieve the best outcome for him/herself just by revealing his or her true preferences, or openly acting on his or her preferences (without “cheating”).

Eric Maskin, in his lecture, “An Introduction to Mechanism Design” (Warwick Economics Summit 2014) uses the simple example of a parent wanting to divide a cake between two children. The goal is to divide the cake in such a way that both children are happy. The mechanism could be that one child cuts the cake while the other has first choice of the pieces. The goal of making a “fair division” is known in advance. The mechanism is designed specifically to achieve that goal.

This “one cuts, the other chooses” mechanism is incentive-compatible because it allows both children to achieve their goal, defined as getting at least half the cake.

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