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- A smart market is a periodic auction which is cleared by the operations research technique of mathematical optimization, such as linear programming. The smart market is operated by a market manager. Trades are not bilateral, between pairs of people, but rather to or from a pool. A smart market can assist market operation when trades would otherwise have significant transaction costs or externalities. Most other types of auctions can be cleared by a simple process of sorting bids from lowest to highest. Goods may be divisible, as with milk or flour, or indivisible, as with paintings or houses. Finding a market-clearing allocation corresponds to solution of a simple knapsack problem, and does not require much computation. By contrast, a smart market allows market clearing with arbitrary constraints. During market design, constraints are selected to match the relevant physics and economics of the allocation problem. A good overview is given in McCabe et al. (1991). Combinatorial auctions are smart markets in which goods are indivisible, but some smart markets allocate divisible goods such as electricity and natural gas. Compared to traditional market structures, a smart market substantially reduces transaction costs, allows competition which would not be possible otherwise, and can eliminate externalities. Despite complex constraints, a smart market allows the benefits of a modern financial exchange system. Fulfilment of the contract is backed by the exchange; parties are generally anonymous; the market manager enforces regulation to ensure fairness and transparency; and markets are orderly, especially during stressful conditions. A smart market may be a one-sided auction in which participants buy from the market manager, a one-sided procurement (reverse auction) in which participants sell to the market manager, or two-sided, in which the market manager balances supplying participants with demanding participants. In a two-sided smart market, the market manager may be a net seller, a net buyer, or simply a revenue-neutral broker. Smart markets are achievable due to an enabling confluence of technologies: the internet to transmit users’ bids and the resulting prices and quantities, increased computation power to run the simulation and linear program, and real time monitoring. (en)
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