For his work in the area of market power and regulation, Jean Tirole has been awarded the 2014 Nobel Prize in Economics (formally, “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”).  Dr. Tirole, who completed his graduate work at the Massachusetts Institute of Technology (MIT), is a French citizen and is the Scientific Director at Institut d’Economie Industrielle at the Toulouse School of Economics in France.

The central bank of Sweden created the Nobel Prize in Economics in 1968, and it is given by the Royal Swedish Academy of Sciences.  Every year, the almost $1.5 million award is given for important work in economics; areas of study include general equilibrium theory, traditional micro and macroeconomics, bargaining theory, and economic history.  In addition, economists and a few others who have found and explained linkages between economics and other arenas (political science, psychology, sociology, law, and others) have been recognized.

Selection criteria used by the Royal Swedish Academy of Sciences include the originality of the contribution, its scientific and practical importance, and its impact on scientific progress.  The effects of the work on society and public policy may also factor into the process.

Jean Tirole’s work has to do with market power and regulation, and his ideas broke new ground in the field.  He brings a rather unique educational background to the table with a combination of engineering, math, and economics degrees.  His understanding of the production process is one factor which shaped his work.

Most traditional economic theory deals with one of two basic market forms.  On one end of the spectrum are monopolies, where there is only one firm in the market (such as a single provider of electric power), and often a need for regulatory oversight to ensure consumer wellbeing.  On the other end of the spectrum is what is known as “perfect competition,” where the presence of many competing firms ensures that prices and quality levels are kept in line.  If one business charges too much for its products or lets quality slide, for example, customers can simply choose to purchase from another.

Before Dr. Tirole’s work, there was little research other than the original exposition and specification in an important alternative market structure, the oligopoly.  An oligopoly is a market where a few large firms can influence prices, quality, and production volumes.  Oligopolies are common in cases where public monopolies have been privatized (which has happened in numerous sectors over the past few decades), and it can be difficult to get to the point where the companies taking over actually behave like private firms.  There is a delicate balance that has to be struck between over-regulation (which stifles creativity and innovation) and under-regulation (where market power can potentially harm consumers).

Around the world, competition has been theoretically introduced in industries ranging from railways to telecommunications to financial services to health care.  It is challenging to determine how much to regulate these newly competitive industries as the transition from a monopoly situation occurs.  There is also a problem of asymmetric information, with regulators inevitably having a less-than-perfect understanding of firm costs and profits.  One tool that has been used by regulators is setting price caps.  If prices set by regulatory agencies are too high, however, they allow excessive profits to the detriment of consumers.  At the same time, the price needs to be high enough for the firm to remain financially viable and make needed investments.  This approach is often simplistic and imprecise and can at times produce outcomes that are not in our best interest.  Prior to Dr. Tirole’s research, there was not a lot of good empirical study to help deal with such issues and develop more efficient structures.

In addition to their usefulness in oligopoly markets, Dr. Tirole’s theories are put into practice in public procurement, where his way of structuring contracts helps ensure sufficient (but not too high) profits for the winning firm.  Others include contributions to our understanding of the competitive effects of patents, technical advances, and strategic investments.

If all markets were highly competitive, they would be efficient and ensure optimal prices and product offerings.  The fact is that they are not.  There are times when competition fails, and there is a real need for regulatory oversight.  However, markets should be analyzed individually to determine what is needed.  There are no “cookie-cutter” solutions.  Jean Tirole has made major contributions to our understanding of how to best approach these situations to ensure a desirable outcome for businesses and consumers alike.