The Economist: Going once…
Two Americans, Dr. Paul R. Milgrom and Dr. Robert B. Wilson of Stanford University, received this year’s Nobel Prize in Economics “for improvements to auction theory and inventions of new auction formats.” Each year, the Royal Swedish Academy of Sciences awards the Prize in recognition of ideas and research that increase our understanding of important issues in economics and related areas. This year’s winners have studied auctions and how they work.
Most of us experience auctions in some form, perhaps through silent bidding at charity events or buying items on eBay. While the concept of auctions has been around for millennia and is generally understood, making them effective and efficient isn’t so simple. It’s particularly complex for certain types of goods and services that aren’t easy to sell through traditional channels, such as frequencies on the radio spectrum or airport landing slots.
I worked on some of the early spectrum sales in the 1980s. The process became so bogged down at times that the federal government ended up assigning access by lottery. Paul and Bob did much to resolve these problems.
One issue arising from auctions of public goods is that the process can actually result in the winning bidder paying too much and impairing its financial sustainability. If a cellular service provider buys radio frequencies but then lacks the resources to fully deploy the needed infrastructure, for example, cell phone service may suffer. In fact, for many public goods, the highest bid may not always yield the best outcome for society.
Dr. Wilson and Dr. Milgrom came up with better structures and formats for auctions, especially in non-traditional situations. In studying auction theory, they gained insight into how rules for bidding and final prices affect outcomes. Much of their work expands on the seminal precepts of game theory originally conceived by the beautiful mind of John Nash.
Bob’s work deals with the concept of a “common value,” which is uncertain at the time of the auction but would be the same for everyone in the end. An example is the actual amount of recoverable oil beneath certain acreage. His theories demonstrate why rational bidders place bids below their own best estimate of the common value because they are afraid of paying too much (the “winner’s curse”).
Paul’s more general theory accounts for common values, but also the possibility of “private values” that vary for each bidder. He found that the auction format gives the seller higher expected revenue when bidders learn more about each other’s estimated values during the auction.
This work has helped not only sellers and buyers, but also taxpayers through boosting revenue and improving social wellbeing in auctions of public goods. The Prize is well deserved. Stay safe.
Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com), which has served the needs of over 2,500 clients over the past four decades.