Context: The Royal Swedish Academy of Sciences awarded the Nobel Prize for Economics (2020) to Paul R Milgrom and Robert B Wilson for their work on auction theory and new auction formats.
- The oldest form of auction: When one thinks of auctions, one typically imagines the auction of a bankrupt person’s property to pay off his creditors.
- Changing nature of auction: With more and more goods and services have been brought under auction, no one auction design fits all types of commodities or sellers. For instance, a bankrupt person’s property is starkly different from the spectrum for radio.
About auction theory:
- Auction theory studies how auctions are designed, what rules govern them, how bidders behave and what outcomes are achieved.
- Essentially, it is about how auctions lead to the discovery of the price of a commodity.
- The auction winner’ curse: The winner's curse is a tendency for the winning bid in an auction to exceed the intrinsic value or true worth of an item. The gap in auctioned vs. intrinsic value can typically be attributed to incomplete information, bidders, emotions, or a variety of other subjective factors that can influence bidders.
- This approach led to a proliferation of lobbying and therefore how an auction is designed has a tremendous impact not just on the buyers and the sellers but also on the broader society.
- Key variables that determine the outcome of an auction: Three key variables need to be understood while designing an auction.
- Rules of the auction.
- The commodity or service being put up for auction.
- Contribution of Milgrom and Wilson:
- Wilson developed the theory for auctions of objects with a common value. Wilson showed what the “winner’s curse” is in an auction and how it affects bidding.
Milgrom formulated a more general theory of auctions that not only allows common values but also private values that vary from bidder to bidder.
Image Source: ET