Designing Markets with Complementarities

Many real-world markets would function poorly if they did not have clear rules and coordinated transactions. The supply of generated electricity must match demand at all times otherwise there will be rolling blackouts. If local authorities do not centralise primary school admissions, many parents would be pressured into accepting places in schools where their children would not thrive. If the government gives away mobile spectrum licenses for free, then spectrum might not end up with telecoms companies that can provide the best service for the public.

Many markets can be drastically improved using insights from a branch of economics called "market design". Market designers use economic theory to develop market rules and create infrastructure that facilitates market transactions. Company shares, commodities, and even electricity are traded in organised exchanges. Centralized two-sided matching markets are used to match doctors to hospitals, children to schools and universities, one incompatible kidney donor-patient pair to another, and army cadets to branches of service. Auctions are used to find the most willing buyers for swathes of mobile spectrum, precious antiques, and search engine adverts.

Market designers have created many ways to design markets that superbly allocate similar (identical or substitutable) items. These include auctions for antiques and preference-based matching systems used by local authorities to allocate children to primary schools.

But one particular feature that drastically complicates the design of markets is complementarity. Things are complements when the value of them together is greater than the sum of their individual parts.

Coming back to an example above, suppose that the government wanted to sell mobile spectrum licenses. Telecoms companies value nearby licenses a great deal as it allows them to provide a better service for customers. Should the government bundle nearby licenses together or sell them separately? Now suppose that in order to sell spectrum licenses to telecoms companies the government first has to buy these spectrum licenses from hundreds of television stations. Should the government buy and sell these licenses at the same time? Finally, suppose that the government could also move some television stations to broadcast on other parts of the spectrum. Which stations should it move while avoiding broadcast interference? Answering all these questions involves tackling different types of complementarity.

There are other examples of real-world markets with complementarities. Property developers bidding in a land auction often want to buy adjacent plots of land. Boat captains often want to exchange some of their fishing quota for quota of other species. In order to avoid blackouts, the electricity grid operator has to make sure that certain fossil fuel and renewable generators are producing energy at the same time.

These examples make clear that in the presence of complementarities market design can be crucial to ensure the market works well. Coordination is required to ensure that as many of the complementary transactions take place as possible. However, when there are complementarities, simple, classic auctions and matching algorithms can fail dramatically. Therefore new theoretical tools are needed.

In this work, I develop new theoretical and practical tools - auctions, matching markets, and trading networks - to design markets with different types of complementarity. I also test one new auction in a series of laboratory experiments. This work has a number of important applications for the redesign of many existing markets and for the design of new ones, including markets for biodiversity conservation, peer-to-peer energy trading, auctions and exchanges of fishing quota, and matching systems for the allocation of resettled refugees.

Every theoretical model developed in this research programme is inspired by, or is directly applicable to, designing real-world markets. Therefore, this research will have an impact on a number of beneficiaries outside academia. In the Pathways to Impact, I address specifically how I will engage and collaborate with these beneficiaries, disseminate my research, and establish opportunities for knowledge exchange.

Project 3 on matching markets with complementarities is directly related to an application of refugee resettlement. Several governments, including the United States, Canada, France, and the United Kingdom, resettle a total of around 100,000 refugees annually directly from refugee camps. These resettlement destinations lack tools to match refugee families to fitting local areas. In this research programme, I will not only develop better algorithms for existing resettlement models, but also link the matching system to financing of resettlement by governments and social impact investors. I am already working closely with one US resettlement agency to create such a matching system and I hope to apply these methods at other agencies and governments. This work also interests a number of foundations and non-governmental organisations, such as the Center for Global Development, Open Society Foundations, and Oxfam.

A key application of Project 1 (auctions with complements) in this research programme is environmental market design, in particular biodiversity conservation and investment in renewable natural resources. If a government agency (e.g. Defra or Natural England) or firms (e.g. Unilever) is interested in investing in biodiversity conservation or ecosystem service provision, they will often be interested in large swathes of land that can comprise many adjacent private properties. This is because natural ecosystems do not usually respect property boundaries but still must be protected as a whole. This work is also related to my involvement in a grant from The Nature Conservancy, an American environmental charity.

As more consumers begin to generate renewable electricity with solar panels and install batteries at home, there will be more intermediaries in the electricity market who are buying and selling electricity. In order to ease power line congestion and create a resilient energy system with a large fraction of renewables, electricity pricing will have to expand from a single market price to locational pricing and eventually to peer-to-peer pricing. I expect that both grid operators and peer-to-peer electricity start-ups will benefit of a new understanding of pricing in networks. These sorts of systems can be easily deployed on micro-grids which are becoming prevalent in rural areas of developing countries. I develop a new theory of networked market design to advance this application in Project 2.

Ideas developed in Project 1 and Project 2 will also benefit stakeholders and producer organisations in the fishing industry. Fishing quota is often allocated through auctions. Many fish species breed together so when fishermen target one fish species they inadvertently catch another species. Since fish discard is often prohibited, fishermen must buy quota for both types of fish making the quota for different species complementary. Another interesting application is an exchange of fishing quota after an auction. Boat captains buy an amount of quota for different species that is based on their projection of marine ecology. However, fishing can be highly unpredictable and once the net is cast and the catch is brought in, boat captains often need to trade quota of one species for another. Boat captains might want to sell some quota and buy quota for other species at the same time. I am already involved with designing fishing auctions in the Faroe Islands. I will explore complex quota auctions and quota exchanges with the Faroese, Scottish, and English fisheries managers based on the results of the research programme.