Vickrey-Clarke-Groves Mechanism and Demand Revelation

“When a distinguished but elderly scientist states that something is possible, he is almost certainly right. When he states that something is impossible, he is very probably wrong.”

The Vickrey-Clarke-Groves mechanism (a.k.a. demand revealing process) is typically attributed to three inventors.  William Vickrey is credited with the original concept, dating back to a paper written in 1961.  Edward Clarke (1971, 1972) was the first economist to successfully apply it to the problem of revealing preferences for public goods, followed by Groves in 1973. 

The demand revealing mechanism works by inducing consumers to pay a certain tax depending upon their stated valuation for a good or service. Essentially, each person agrees to either accept a social decision that would be made without his participation, or change the decision to what s/he wants, upon payment of money equal to the net cost to all other persons to enact his or her preferred policy over their preferences.

Assume for a moment that you have three voters, trying to decide whether there should or should not be a new bridge in their city.

The valuation of each voter is added to determine which outcome (not building or building the bridge) wins.  Each voter’s individual valuation is then examined to determine if it changes the outcome of the vote.  For example, if they were removed from the election, would the outcome change?  If their valuation/vote does tip the balance, they must pay a tax equal to the benefits the other voters would experience if their preferred policy had been enacted.  On the other hand, If the presence of an individual in the election does not change the outcome, they are not required to pay any tax.

Under this procedure, there is no incentive to understate one’s valuation, for if you do, your desired outcome may lose the vote and not be enacted at all.  If an individual overstates their valuation, they risk paying a tax which could exceed the benefits you expect to receive from the policy or outcome.  Therefore, the mechanism induces honest revelation of preferences.

The demand revealing process has been shown to strike down several problems which have plagued economics for decades: the free rider problem, tragedy of the commons, the prisoner’s dilemma, and inefficient provision of public goods.   
This revolutionary procedure has implications for improved government performance relating to taxation, spending, government regulatory management and auctions.