‘The prize in Economic Science 2020’

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2020 was awarded jointly to Paul R. Milgrom and Robert B. Wilson "for improvements to auction theory and inventions of new auction formats."

• The prize for economics is officially known as the Sveriges Riksbank Prize in Economic Sciences.
• It was established by Sweden's central bank and has been awarded since 1969 in memory of industrialist Alfred Nobel.

What is auction theory?

• 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
  • what outcomes are achieved
• Over time, more and more goods and services have been brought under auction.
• The nature of these commodities differs sharply. For instance-
  • A bankrupt person’s property is starkly different from the spectrum for radio or telecom use.
  • Similarly, carbon dioxide emission credits are quite different from the spot market for buying electricity, which, in turn, is quite different from choosing which company should get the right to collect the local garbage.
• In other words, no one auction design fits all types of commodities or seller.
• This is also true because the purpose of an auction also differs with the commodity and the entity conducting the auction. More often than not, private sellers want to maximise their gains while public authorities may have other goals in mind.

What are the key variables that determine the outcome of an auction?

Three key variables need to be understood while designing an auction.

• Rules of auction: The bidding behaviour is likely to differ if the rules stipulate open bids as against closed/sealed bids. The same applies to single bids versus multiple bids, or whether bids are made one after another or everyone bids at the same time.
• Commodity/ service put up for auction: The second variable is the commodity or service being put up for auction. In essence, the question is how does each bidder value an item. This is not always easy to ascertain. In terms of telecom spectrum, it might be easier to peg the right value for each bidder because most bidders are likely to put the spectrum to the same use. This is called the “common” value of an object.
  • But this may not be the case with some other commodities, say a painting.
  • Person A may derive considerably more “private” or personal value — just by looking at it endlessly — than person B.
  • In most auctions, bidders allocate both “common” as well as “private” values to the object being auctioned and this affects their eventual bids.
• Uncertainty: The third variable is uncertainty. For instance, which bidder has what information about the object, or even the value another bidder associates with the object.