Economics Should Inform Design
Updated: June 2013

Online platforms mediate the interaction of different types of users with each other. Whenever users interact there is the potential for both positive and negative externalities. Some users, by doing what is rational for themselves, create additional costs for others. For example, people choose to drive without considering the impact the have on traffic for others. Externalities can often be mitigated by carefully choosing the rules by which users interact with each other and the platform.

Mechanism / Market design is an entire academic field that studies how to set up the “rules” of the game so that the best outcome occurs. The solutions that market design offers often involve carefully placing a price on certain actions or eliciting private information from users in clever ways. Other solutions involve deliberately setting the timing at which information is revealed to users or changing the rules that determine the order in which results are displayed in search.

Yahoo ran the best documented use of market design of all the online platforms. In 2008, Yahoo changed its auctions to include a reserve price (i.e. a price beneath which the ad could not be sold). Following the change, revenues increased significantly. The reason that a reserve price increased revenue is that the previous auction format, a second price auction, allowed advertisers to pay a lot less than they were willing to pay. The reserve price allowed Yahoo to use its market power to extract more revenue.

Two other examples of platforms that have used the principles of mechanism design are Quora and LinkedIn. Quora’s credit system rewards good actions on the site such as writing great answers or questions. LinkedIn gathers information about users’ expertise through low friction prompts to [endorse] (http://www.forbes.com/sites/susanadams/2012/12/04/everything-you-need-to-know-about-linkedin-endorsements/) connections.

Below are some other examples of interesting platform design questions.

If you want to learn more, Al Roth’s market design page and blog are great starting resources.

Please email comments to: afradkin (at) gmail (dot) com