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Auction Theory explained: Why Nobel Prize in Economics went to Paul Milgrom, Robert Wilson  


Paul R Milgrom and Robert B Wilson jointly won this year’s Nobel Prize in Economics. The Royal Swedish Academy of Sciences announced the winners of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2020 — as the Nobel Prize in Economics is officially called — in Stockholm on Monday.

American economists Paul Milgrom and Robert Wilson were chosen for the Nobel Prize in Economic “for improvements to auction theory and inventions of new auction formats.”

The Royal Swedish Academy of Sciences said, “The new auction formats are a beautiful example of how basic research can subsequently generate inventions that benefit society. The unusual feature of this example is that the same people developed the theory and the practical applications.”

“The Laureates’ ground-breaking research about auctions has thus been of great benefit for buyers, sellers and society as a whole,” it said.

So, what is the Auction Theory?

Auction Theory is a concept of transparent allocation of resources or items of business in a free market to the best bidder for optimum utilisation. It is a branch of applied economics. Auction Theory prescribes different sets of rules or designs for transactions.

Why is Auction Theory important enough to fetch a Nobel?

It is common for people to sell items to the highest bidder, or conversely, buy things from whoever makes the cheapest offer. Now in an open globalised market and technological advancements, items and resources worth astronomical sums of money change hands every day in auctions. From houses, cars and shops to electricity, telecom spectrum, minerals and precious metals too are auctioned.

Governments use auctions to sell treasury bills, foreign exchange, oil fields, land, airports, railways and similar resources as they move towards privatisation of economy. Public procurements — including foodgrains for making them available to the vulnerable sections of society — are done through auctions.

Auctions thus impact every sphere of an individual’s life in a free-market society. If electricity generation or distribution is auctioned to a higher bidder, the power bills of every household and office will go up.

How does Auction Theory help in this?

It helps understand the evolving nature of bidding and pricing of items and resources in a country or globally. The Nobel Committee said the researchers use the Auction Theory to understand the outcomes of different rules for bidding and consequent final prices. This forms the auction format.

Analysing auction formats is difficult as bidders behave according to their own specific strategic needs, based on information they have about the item and its utility for their benefit. The bidders take into consideration what they know themselves as well as what they believe other bidders to know.

What did the two Nobel Prize winners do?

According to the Royal Swedish Academy of Sciences, Robert Wilson developed the theory for auctions of objects with a common value — a value which is uncertain beforehand but, in the end, is the same for everyone.

Examples include the future value of radio frequencies or the volume of minerals in a particular area. Wilson showed why rational bidders tend to place bids below their own best estimate of the common value: they are worried about the winner’s curse — that is, about paying too much and losing out, the Royal Swedish Academy said in its press statement.

On the other hand, Paul Milgrom formulated a more general theory of auctions that not only allows common values, but also private values that vary from bidder to bidder.

Milhtom analysed the bidding strategies in a number of well-known auction formats. He showed that a format would give the seller higher expected revenue when bidders learn more about each other’s estimated values during bidding.

Milgrom and Wilson invented new formats for auctioning off many interrelated objects simultaneously. In 1994, the US first used one of their auction formats to sell radio frequencies to telecom operators. It was found to be very useful and since then, many other countries have used their formats.

Their discoveries are of great benefit to society, said the Nobel Prize Committee chairperson Peter Fredriksson in his statement.



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