Two Americans, Lloyd Shapley and Alvin Roth, have won the Nobel Prize in Economics (formally “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”). The Prize, which was instituted in 1968, by the central bank of Sweden, is given by the Royal Swedish Academy of Sciences. The $1.5 million prizes are given for work in economics in areas of study such as general equilibrium theory (how everything hangs together), traditional micro and macroeconomics, bargaining theory, and economic history. In addition, economists who have found and explained linkages between economics and other arenas (political science, sociology, law, and others) have also been recognized.
Selection is based on the originality of the contribution, its scientific and practical importance, and its impact on scientific progress. In addition, the effects of the work on society and public policy may factor into the process. This time around, it is readily apparent how the work is (and could be) used in a number of contexts.
Within any academic discipline, there are those concepts which are theoretically examined, discussed over coffee, or even written about in the most abstract terms…yet never come to fruition in a body of research and knowledge which can ever be put to practical use. At the same time, there are researchers yearning for a theoretical construct they can sink their teeth into and put together empirical studies and results.
This year’s Prize is an example of the important advances that can be realized when the theoretician meets the empiricist. Though Lloyd Shapley and Alvin Roth worked independently, as the Royal Swedish Academy of Sciences puts it, “the success of their research is due to the combination of Shapley’s theoretical results with Roth’s insights into their practical value.”
Most of economics deal with the interaction of supply and demand in determining a price. When a particular good is plentiful in relation to demand (say, for example limestone), the price will be relatively low. If, on the other hand, the supply is low compared to demand (say, for example, diamonds), the price will be relatively high. Market participants adjust their behavior based on price.
However, there are some markets where there simply isn’t a price to go by. These may include things like public schools which are prohibited from charging tuition or fees, human organs for transplant, doctor services, or even marriage. Given that these situations still involve scarce resources, how are allocations made in the absence of price?
Enter Shapley and Roth. In the 1960s, Lloyd Shapley began to explore the idea that if rational people simply engage in unrestricted trade, they will reach the point where they are “stable,” meaning that no further trade would make them better off. In 1962, Shapley (working with David Gale) discussed “pairwise matching.” Using marriage as an illustrative example, Gale and Shapley looked at how pairs were matched up and who ended up better off (those who proposed or those who were proposed to). The resulting paper was on academic reading lists for decades (and still is).
It wasn’t until the early 1980s, however, that other aspects of the ideas’ relevance were explored by Alvin Roth. Mr. Roth noted that the Gale-Shapley findings bore a notable resemblance to a successful matching program for new doctors and hospital settings (the National Resident Matching Program). Essentially, the Program led to “stable” relationships of the type predicted by Mr. Shapley’s work. However, also as predicted by the Gale-Shapley work, the hospitals (those doing the proposing) ended up better off than the doctors (those being proposed to), which led to notable problems. Alvin Roth helped design a better system. This work has positively impacted economic efficiency and even human life and provided the underpinnings of today’s matchmaking services decades before the Internet became a household staple.
Many of the most important advances come from a combination of theoretical advancement and empirical application and extension. This year’s Nobel Prize winners in economics are certainly an example, with all of us the beneficiaries.