Nobel Prize in Economics
U.S. economists Paul Milgrom and Robert Wilson won the Nobel Economics Prize for work on commercial auctions, including for goods and services difficult to sell in traditional ways such as radio frequencies.
- The duo was honoured “for improvements to auction theory and inventions of new auction formats”.
- Mr. Wilson, a professor at Stanford in the U.S., was spotlighted for developing a theory for auctions with a common value, “a value which is uncertain beforehand but, in the end, is the same for everyone”.
- Mr. Wilson’s work showed why rational bidders tend to bid under their own estimate of the worth due to worries over the “winner’s curse,” or winning the auction but paying too much.
- Mr. Milgrom, also at Stanford, then came up with a more general theory of auctions, by analysing bidding strategies in different auction forms. While “people have always sold things to the highest bidder,” societies have also had to allocate “ever more complex objects… such as landing slots and radio frequencies.”
- In response, Milgrom and Wilson invented new formats for auctioning off many interrelated objects simultaneously, on behalf of a seller motivated by broad societal benefit rather than maximal revenue”.
What is ‘auction theory’?
- Essentially, it is about how auctions lead to the discovery of the price of a commodity. Auction theory studies how auctions are designed, what rules govern them, how bidders behave and what outcomes are achieved.
- Three key variables need to be understood while designing an auction.
- One is the rules of the auction. Imagine participating in an auction. Your bidding behaviour is likely to differ if the rules stipulate open bids as against closed/sealed bids. The same applies to single bids versus multiple bids, or whether bids are made one after another or everyone bids at the same time.
- The second variable is the commodity or service being put up for auction. In essence, the question is how does each bidder value an item. This is not always easy to ascertain. In terms of telecom spectrum, it might be easier to peg the right value for each bidder because most bidders are likely to put the spectrum to the same use. This is called the “common” value of an object. But this may not be the case with some other commodities, say a painting. Person A may derive considerably more “private” or personal value — just by looking at it endlessly — than person B. In most auctions, bidders allocate both “common” as well as “private” values to the object being auctioned and this affects their eventual bids.
- The third variable is uncertainty. For instance, which bidder has what information about the object, or even the value another bidder associates with the object.