October 13, 2020 | Investopaper
Paul Milgrom and Robert Wilson, two Stanford University professors, have been awarded the Nobel Prize in Economics. The award was presented to them by the Royal Swedish Academy of Sciences for their contribution for improvements to auction theory and inventions of new auction formats. They worked on how the auction works. They also set up a new auction system for the sale of goods and services that were traditionally difficult to sell. According to the Academy, buyers, sellers and taxpayers around the world have benefited from such formats as radio frequency auctions.
People have always sold goods to the highest bidder and bought from the cheapest offers. But nowadays, huge sums of money are bought and sold in the auction every day, not only household goods, art and archaeological items, but also securities, minerals and energy are bought and sold in the auction. Public procurement is also done on auction. Using auction theory, researchers try to understand the outcomes of different rules for bidding and final prices, the auction format.
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.
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. He analysed the bidding strategies in a number of well-known auction formats, demonstrating that a format will give the seller higher expected revenue when bidders learn more about each other’s estimated values during bidding.
In 1994, the United States first used a format developed by these two economists to sell radio frequencies to telecom companies. Since then, many countries around the world have used this format. The Nobel Prize in Economics, founded by the Swedish Central Bank, has been awarded since 1969 in memory of scientist and industrialist Alfred Nobel. This year, the two economists will share a prize of 1.1 million dollars.