Jean Tirole wins 2014 Nobel Prize in Economics
Yesterday the Royal Swedish Academy of Science in Stockholm announced this year’s Nobel Prize in Economics: It goes to Jean Tirole from the Toulouse School of Economics. Most of Jean Tirole’s numerous theoretical insights are in the field of the Industrial Organization, which several researchers at ISTO also work on. Therefore, it seems appropriate to summarize Jean Tirole’s contribution shortly.
While Macroeconomics looks at whole countries as its unit of observation and Microeconomics look at individuals, Industrial Organization is the sub-field of economics that looks at individual markets, i.e. “industries”. A typical question in Industrial Organization is why some markets are dominated by large monopolies while in other markets numerous firms compete vigorously. A related question is that if we have a dominant firm that abuses its monopoly power in a market by charging high prices, what can the government do to improve the situation? Jean Tirole has contributed considerably to the field and his insights are now regularly applied to practical questions such as the regulation of telecommunication markets or competition policy in internet markets.
While it is hard to single out a single contribution by such a versatile scholar as Jean Tirole, we want to highlight one famous paper co-authored with Jean-Charles Rochet which will look very familiar to our students of Management and Economics of Network Industries. In their paper, Rochet and Tirole lay down the theory of “two-sided” or “platform markets”. Their insight is that many modern markets, from credit-cards to internet search engines, are best understood as firms selling the same good to two distinct groups of buyers at the same time. For instance, a credit-card company offers credit-cards to consumers, but at the same time has to make sure that as many merchants as possible accept its credit cards. Offering credit-cards to consumers but not to merchants and vice-versa would not make any sense. This raises an interesting question: If the credit-card company has to attract two distinct groups at the same time, how should it set the two prices for the two groups? Tirole and Rochet came up with an elegant answer: The group which has the higher “need” for the other group should pay more. This explains for example why Google does not charge users but charges advertisers: Users do not derive any additional value from seeing advertisements, but for advertisers it is crucial that as many users as possible see their ads. Tirole and Rochet’s theory has many practical implications for modern regulation, as especially in the internet-economy two-sided markets are pervasive. Indeed, the theoy of two-sided markets sounds remarkably simple once its principles have been laid out, and people start to see two-sided markets everywhere in our economy, yet this was only the case after Jean Tirole and his colleague Jean-Charles Rochet formulated it.
While Jean Tirole was awarded the Nobel-Prize for his theoretical insights, many students of economics know him mainly as the author of his classic textbook “The Theory of Industrial Organization”. Although many important insights in Industrial Organization are buried in complicated-looking math, Jean Tirole is able to strip them down to only the most basic and necessary expressions, while preserving the full beauty and meaning of the original insight. This is one of the reasons why this book is still, more than 25 years after its first edition, seen by many as the “bible” of Industrial Organization.
A well-known economist once remarked “We all should either strive to do theoretical models like Jean Tirole, or stop doing models at all and only do empirical research.” While this was more meant as a comment on the field, it beautifully summarizes the essence of Jean Tirole’s work.