Economics Lessons from the Latest Nobel Laureate Jean Tirole
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Jean Tirole

(Image: Nobel Laureate Jean Tirole)

On Monday, Jean Tirole, a 61-year old professor at France’s Toulouse University, was honored with the $1.1 million Nobel Memorial Prize in Economic Sciences “for his analysis of market power and regulation.”

Tirole is a part of group of some very influential economists from the Toulousse School of Economics who produced several significant pieces in Industrial Organization. Jean-Jacques Laffont, Patrick Rey, Paul Seabright, Marc Ivaldi and Jean Charles Rochet are some of the most well-known economists besides him.

"He has given us an instruction manual for what tool to use in what market," said Torsten Persson of the prize committee. "Politicians would be stupid not to take his policy advice."

Tirole has done top notch work, utilizing game theory to analyze markets in which there are single or a couple of predominant dealers. He had been tipped for a Nobel Prize since quite a long time. A good number of economists would likely be of the same opinion that he is worthy of the merited prize.

Right from late 1960s to the early 1980s, the field of industrial organization was ruled by the Chicago School, where four of the real players were the late George Stigler (who was merited with the Nobel Prize in 1982), his associates Sam Peltzman and the late Yale Brozen, and UCLA economist Harold Demsetz. They contended that despite the fact that most businesses don't fit the economists' model of "perfect competition" in which no firm has the ability to set a value, this present reality was bounty aggressive. Firms contend by cutting expenses, by cutting cost and by being inventive. These economists' understanding of the omnipresence of rivalry headed them to be distrustful about much of antitrust law and most government regulation.

Regulators and Incentives

In the 1980s, Tirole employed game theory to the field of industrial organization. The key thought here is that organizations with market power consider how their adversaries are liable to respond when they change rates or item offerings. The Chicago School economists perceived this however did not thoroughly utilize game theory to delineate a portion of the suggestions, which however, Tirole did.

Tirole and his late associate Jean-Jacques Laffont focused on “asymmetric information”. A regulator has less data than the organizations it standardizes. Along these lines, if the controller speculated any bit erroneous around a regulated firm’s expenses, which is dreadfully possible, it could set costs excessively low or excessively high. Tirole, Laffont and Messrs, demonstrated in 1986 that a smart controller could balance this asymmetry by building contracts and letting the firm pick which contract to acknowledge.

"If Jean Tirole can be said to make one idea, it's that the world is complicated," says economist Alex Tabarrok. "And a lot of things can change depending upon small differences in who knows what information."

Assume that a few firms can bring down their expenses which other firms can't, yet the controller can't recognize them. A controller may offer the organizations either a cost-plus contract or a fixed-price contract. The expense in addition to contract will engage firms with high expenses while the settled value contract will attract those organizations that can bring down their expenses. Thus the controller keeps up incentives to lower costs.

These bits of knowledge are most straightforwardly relevant not to regulation however to government bodies like the Defense Department when it arranges with firms giving heavy goods such as boats, tanks and planes.

"Precisely because different rules are optimal in different circumstances, the regulator, even a sophisticated regulator, might not be able to pull off the trick which Tirole recommends that they try," Tabarrok says.

George Mason economist Tyler Cowen 's first response to Monday's prize report, posted on his Marginal Revolution site, was that Mr. Tirole's work is truly about principal-agent hypothesis, not about controlling huge businesses. In the Defense Department illustration here, the contractor is the agent and the Pentagon is the principal.

Two-Sided Markets

Tirole additionally has analyzed two-sided markets in which organizations sell to two separate groups of consumers. Take an example of Google; it can rate its services to users (one side) and its services to advertisers (the other side). The higher the cost to users, the smaller number of users and, accordingly, the less cash Google would make from advertising. Google's decision is to lay down a zero price to users and to charge for advertizing. Another example is of credit card companies, which apply this strategy to pay their customers who use the cards in order to charge the dealers massive amounts of fees. One more application of this strategy is for newspaper (users: readers and clients: advertisers) as well as video games (users: gamers and clients: developers). In 2006 Tirole and Jean-Charles Rochet showed that the assessment about profit-maximizing rate is problematical, and they do some intense math to figure such costs under different hypothetical conditions.

However they don't confer the slip-up of the opinion that controllers are fundamentally superior to firms in setting costs. Consider the most recent example of interchange fees (IF) in payment-card associations like Visa and MasterCard. A majority of controllers have bolstered government regulation of such charges. Nonetheless in 2003, Messrs. Rochet and Tirole composed that “given the economics profession’s current state of knowledge, there is no reason to believe that the IFs chosen by an association are systematically too high or too low, as compared with socially optimal levels.”

"I was incredibly surprised at the honor, and it took me half an hour to recoup" said Tirole in an interview with the website

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