Paul R. Milgrom and Robert B. Wilson were awarded Nobel Prize in Economics for improving the auction theory. We see auctions all around us – from IPL player auctions, to selling antique items, to spectrum allocation. Let’s understand what ‘the auction theory’ is and how Milgrom and Wilson contributed to its improvement.
Crux of the Matter
Nobel In Economics
This year Paul R. Milgrom and Robert B. Wilson were awarded Nobel Prize in Economics for improving the auction theory. So far, 51 times the Nobel Prize in Economics has been awarded and 89 laureates have been honored. Last year Indian-American economist, Abhijit Vinayak Banerjee, his wife Esther Duflo, and Michael Kremer won Nobel Prize in Economics for “their experimental approach to alleviating global poverty”.
What Are Auctions?
Auctions are all around us. It won’t be an understatement to say IPL has acquainted most of us to auctions. It is a process where people bid to purchase any goods and services. In Economics, it is considered one of the efficient mechanisms for distributing resources. Moreover, internet platforms have made auctions very dynamic and the bidding process very easy.
In auction different terminologies are used such as common value, Dutch auctions, etc. Let’s understand what some of them mean.
Common Value: Common value is inferred as the true value of the product that is perceived to be the same for everyone. Therefore, the actual value of the product is the same for all bidders. Examples of this are spectrum auction, drilling auction, etc.
Private Value: It is referred to as the independent valuation of the product. Each bidder has a different ‘perceived value’ of the product.
English Auction: In an English auction, bidding starts with low prices and increases over time. IPL Auctions are an example of the English auction.
Dutch Auction: In a Dutch auction, bidding starts with a high price and descends over time. The price descends until someone is ready to buy the item or if it reaches a predetermined reserve price.
What Is The Auction Theory?
Auction Theory was first academically presented by William Vickrey, who developed the Vickrey Auction and even won the Nobel Prize in 1996 for advanced work in auction theory. The auction theory focuses on three main features of auctions:
– The first feature talks about the type of bidding, the number of times one can bid, and pricing
– The second feature talks about how bidders value auctioned objects, and
– The third feature talks about how the information a bidder has about the object affects the auction.
Vickrey’s auction was a closed-bid auction in which no bids were disclosed. In it, the highest bidder (winner) pays the second-highest price.
Winner’s curse is a phenomenon in which a person for whom the private value of a product is higher may end up paying much higher than the actual value. Wilson showed how bidders’ attempts to escape the winner’s curse may result in lower revenue for the seller or failure of the auction. Milgrom’s work showed that bidders get leverage when they have information.
Extension To Auction Theory
Milgrom and Wilson extended the English Auction format to more than one item, and multiple rounds and named it Simultaneous Multi-Round Format. In this format, bidders can bid for multiple items in each round. At the end of a round, the highest bid and the bidder on each item is declared. Sometimes all the bids are disclosed after a round, or sometimes only the highest bids are disclosed (like the closed-bid auction of Vickrey) – depends on the auction rules or activity rules. Auction ends when there is no one raising the bid. The highest bidders for each item then receive it for the bid price.
Robert Wilson and Paul Milgrom showed the application of Auction Theory. They designed an auction strategy for allocating radio spectrums to telecom operators in 1994 in US. It proved to be beneficial to all the three stakeholders i.e. government, telecom companies, and public. Between 1994-2014, US government earned $120 billion using Wilson and Milgrom’s auction model.
This strategy is widely used across countries and across sectors such as electricity and natural gas, which require efficient allocation due to their limited supply.
- The word “auction” is derived from the Latin ‘auctum’ meaning, “I increase”. For most of history, auctions have been a relatively uncommon way to negotiate the exchange of goods and commodities. The practice picked up after the 17th Century.
- A candle auction is a variation on the typical English auction that became popular in the 17th and 18th centuries. In a candle auction, the end of the auction is signaled by the expiration of a candle flame, which was intended to ensure that no one could know exactly when the auction would end and make a last-second bid.
- In 2008, the US National Auctioneers Association reported that the gross revenue of the auction industry for that year was approximately $268.4 billion, with the fastest growing sectors being agricultural, machinery, and equipment auctions and residential real estate auctions.
- Emma Bailey was the first American woman auctioneer, and the first woman admitted to the National Auctioneers Association. Bailey held her first auction in 1950 and continued her career for almost 20 years.