Browsing by Subject "Mechanism Design"

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Electronic service allocation with private quality information
(2017) Widmer, Tobias; Kirn, Stefan
The efficient allocation of electronic services is a complex business problem. Customers demand electronic services from service providers who supply these services at a specified quality of service (QoS). Electronic marketplaces provide a platform on which multiple customers and multiple providers negotiate the allocation of electronic services. Such marketplaces might be administrated by government authorities or large corporations who aim at a socially optimal allocation. This research addresses the allocation problem for electronic services with private quality information from a mechanism design perspective. By assigning specific reservation functions, multiple customers and multiple providers enunciate their preferences for these services. Once all demands and offers for electronic services are submitted, the mechanism determines an allocation that maximizes the sum of the aggregated preferences. However, the design of such mechanisms is difficult because of the following requirements: (1) Double-sided competition: Multiple competitive customers and multiple competitive providers must be matched together appropriately to generate maximal surplus, (2) QoS-awareness: The QoS desired by customers and the QoS offered by service providers must be internalized in the allocation mechanism, (3) private information: The mechanism must facilitate the allocation of electronic services for which any QoS information is unknown, (4) incentive compatibility: The mechanism has to provide adequate incentives to strategic individuals in order to ensure truthful bidding, (5) individual rationality: The participation decision in the mechanism must be voluntarily to all bidders, (6) budget balance: The mechanism must omit any independent intermediary in order to facilitate distributed decision-making among the participants, (7) optimality: The ultimate objective of the mechanism is to achieve an outcome that is optimal from a social welfare perspective. Standard impossibility theorems from mechanism design theory assert that meeting these requirements simultaneously is not attainable. In particular, ex post optimality cannot be attained when incentive compatibility, individual rationality, and budget balance are required as well. Therefore, the mechanism designer must decide about a viable tradeoff of these requirements. One possible compromise in the presence of privately known QoS is to derive a second-best mechanism that satisfies incentive compatibility, individual rationality, and budget balance. The outcome of such second-best mechanisms can be used to estimate the efficiency loss that must be tolerated in comparison to the first-best outcome. The objectives of this research are to (1) develop a second-best mechanism for allocating electronic services with private quality information and (2) study its efficiency properties in a set of simulation experiments to demonstrate its usefulness. All experiments imply that the asymptotic efficiency of the second-best mechanism is bounded away from 100% even for large markets. This finding is related to the economic concept of informational smallness, which is defined as the incremental impact of an participants QoS on the demand of an electronic service. In the proposed model, each provider offers a service of distinct QoS, and each customer demands a service of distinct QoS. It is this feature of differentiated service quality that prevents the participants from becoming informationally small as the market becomes large. If each participant’s private information about QoS follows the uniform distribution, the mechanism must tolerate an efficiency loss of more than 31% for an increasing number of customers and providers. In contrast, if private quality information is normally distributed among participants, this research finds that the mechanisms asymptotic inefficiency can be reduced to about 7% as the market size increases on both sides. With asymmetric, beta-distributed QoS, the mechanism arrives at an asymptotic efficiency of more than 91%. These findings are crucial to social planners because in designing service allocation with double-sided competition, they can obtain an accurate estimation of potential efficiency losses that arise from asymmetric information about QoS. On the other hand, the social planner can ensure that every allocation decision is made by the participants only. Hence, the emerging mechanism implementation eludes the need for an external, independent decision maker.