Oct. 15 (Bloomberg) -- Leonid Hurwicz, Eric S. Maskin and Roger B. Myerson won the Nobel Prize in economics for theories that analyze imperfections in the marketplace and help set rules for transactions ranging from government-bond auctions to elections.

The three Americans will share the 10 million-kronor ($1.56 million) prize for ``having laid the foundations of mechanism- design theory,'' the Royal Swedish Academy of Sciences said today in Stockholm.

Their work, based on ideas first proposed by Hurwicz, 90, helps explain what happens in markets when competition isn't completely free and not everyone has the same information or goals. Mechanism-design theory has been used in labor negotiations, taxation and pricing stock options, in addition to designing auctions.

``They made a fundamental advance by drilling down into the details of people's incentives,'' said Raghuram Rajan, a former chief economist for the International Monetary Fund who's now a University of Chicago professor. ``It has applications throughout the economy and policy-making.''

Among the applications: Advertising auctions at Google Inc., owner of the world's most popular search engine.

``We are one of the most active users of mechanistic design,'' said Hal Varian, chief economist at Mountain View, California-based Google. In the auctions, advertisers place bids to have their messages displayed on Internet pages.

Mechanistic-design theory might also help explain recent turbulence in financial markets, said Richmond Federal Reserve Bank President Jeffrey Lacker.

Credit Markets

Lacker, who wrote papers on mechanistic design as an academic before joining the Fed in 1989, said the theory suggests that a lack of information was a more important constraint on credit markets than was a shortage of liquidity.

He said that's why banks didn't borrow heavily from the Fed, even after it reduced the rate it charges them by a half percentage point on Aug. 17. At the same time, banks remained reluctant to lend to each other because they were unsure how exposed other financial institutions were to potential losses on subprime loans.

The academy said today that Maskin and Myerson helped improve and develop Hurwicz's ideas.

``I feel very happy that people appear to recognize it's an important line of thinking in modern economics,'' Hurwicz said in an interview from Minneapolis. ``Some of the brightest young minds in economics have begun to follow it, which is nice. It's important for economic policy for trying to unify different approaches rather than leaving people to fight it out.''

Einstein's House

Maskin, 56, whose house in Princeton, New Jersey, was once the residence of Albert Einstein, called mechanism design ``the reverse engineering part of economics.''

``There are some things we want that are never going to be attainable by markets,'' he said in a telephone interview. ``If we are going to get them at all we have to find alternative ways of delivering them. That's where mechanism design comes in.''

Maskin has published papers on alternatives to majority rule in elections and on what sort of auctions raise the most revenue. Partly as a result of this work, Maskin was asked in the early 1990s to advise the Bank of Italy on reforms in their system of auctioning treasury bonds.

Myerson, 56, the author of ``Game Theory: Analysis of Conflict,'' developed a mathematical model for analyzing elections and has published more than 70 papers on game theory and other topics.

Incentives

``The problem of giving people incentives to share information is central,'' he said at a press conference today in Chicago. ``We realized that not just resource constraints are important, but incentive constraints. These are now understood to be fundamental parts of the economic problem.''

He said his ``favorite application'' of the theory is in situations where a mediator tries to forge an agreement through negotiation and finds all sides acting in their own interest. The mediator then tries to set a goal to push them toward.

``Mechanic design teaches him, if he wants to serve the bargaining parties as well as possible, he may have to take some risks,'' Myerson said.

In conferring the award, the Royal Academy said the work of the three recipients ``allows us to distinguish situations in which markets work well from those in which they do not. It has helped economists identify efficient trading mechanisms, regulation schemes and voting procedures.''

Born in Moscow

Hurwicz, a U.S. citizen born in Moscow, is an emeritus professor at the University of Minnesota in Minneapolis.

Maskin, a New York City native, is a professor at the Institute for Advanced Study in Princeton. Boston-born Myerson is a professor at the University of Chicago.

The prize, officially known as The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, has been given out since 1969 by Sweden's central bank. Past winners include Milton Friedman, Amartya Sen and Friedrich August von Hayek. Columbia University's Edmund S. Phelps won last year for his theories on inflation expectations and unemployment.

``The selection committee is getting away from straight technical, traditional economics and dealing much more with modern issues of information theory and game theory and institutional theory,'' Thomas Schelling, a retired professor of the University of Maryland and winner of the 2005 prize, said in an interview. ``The three people today are all concerned with the differences institutions make.''

To contact the reporters on this story: Rich Miller in Washington rmiller28@bloomberg.netSimon Kennedy in Paris at skennedy4@bloomberg.netJonas Bergman in Stockholm at jbergman@bloomberg.net

Last Updated: October 15, 2007 18:41 EDT