AUCTION THEORY

 

American economists Paul R. Milgrom and Robert B. Wilson, both of whom teach at Stanford University, were awarded the 2020 economics Nobel Prize. This year’s Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded to the duo “for improvements to auction theory and inventions of new auction formats”. The Nobel Prize committee noted that Dr. Milgrom and Dr. Wilson did not just come up with original ideas in auction theory, but they also played a crucial role in implementing their ideas. 

INTRODUCTION

Auction theory is an applied branch of economics which deals with how people act in auction markets and researches the properties of auction markets. 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. The allocation of scarce resources, in turn, matters to economists because there is a limited supply of resources on earth when compared to unlimited human needs, and hence they need to be allocated only to the most urgent needs of society. In particular, auction theory deals with the various ways in which auctions can be done to improve seller revenues, increase benefits to consumers, or even achieve both these goals at the same time.

IMPORTANCE OF AUCTIONS

Auctions, for a good reason, have been the most common tool for thousands of years used by societies to allocate scarce resources. When potential buyers compete to purchase goods in an auction, it helps sellers discover those buyers who value the goods the most. Further, selling goods to the highest bidder also helps the seller maximize his or her revenues. So, both buyers and sellers benefit from auctions.

ECONOMIST’S CONTRIBUTION TO AUCTION THEORY

To understand Dr. Milgrom and Dr. Wilson’s contributions, it is important to take note of the criticisms levelled against auctions. 

The most common one is that auctions can lead buyers to overpay for resources whose value is uncertain to them which is known as the ‘winner’s curse’, is based on a study that showed how buyers who overpaid for U.S. oil leases in the 1970s earned low returns. Dr. Wilson was the first to study this matter. He found that rational bidders may decide to underpay for resources in order to avoid the ‘winner’s curse’, and argued that sellers can get better bids for their goods if they share more information about it with potential buyers. Dr. Milgrom added further nuance to this analysis by arguing that individual bidders may still submit vastly different bids due to their unique circumstances. 

Secondly, economists traditionally working on auction theory believed that all auctions are the same when it comes to the revenues that they managed to bring in for sellers. The auction format, in other words, did not matter. This is known as the ‘revenue equivalence theorem’. But Dr. Milgrom showed that the auction format can actually have a huge impact on the revenues earned by sellers. In particular, Dr. Milgrom showed how Dutch auctions, in which the auctioneer lowers the price of the product until a buyer bids for it, can help sellers earn more revenues than English auctions. In the case of English auctions, the price rises based on higher bids submitted by competing buyers. But as soon as some of the bidders drop out of the auction as the price rises, the remaining bidders become more cautious about bidding higher prices.

CONCLUSION 

Dr. Milgrom and Dr. Wilson, however, are most popular for their contribution towards devising new, real-world auction formats. The contributions of Dr. Milgrom and Dr. Wilson have helped governments and private companies design their auctions better. This has, in turn, helped in the better allocation of scarce resources and offered more incentives for sellers to produce complex goods.