An auction is an alternative to the market to determine an equilibrium price for a good or service. Although the first thing that comes to mind is an auctioneer lowering the hammer to deliver the good to the bidder whose offer has been the highest, there are other auction formats
In 2020, the Nobel Prize in Economics went to Paul R. Milgrom and Robert B. Wilson, both from Stanford University, for their contributions to auction theory and pricing.
Announcing the award, the Swedish Academy said in its statement: “They have improved auction theory and invented new formats, benefiting sellers, buyers and taxpayers around the world.” He added: “Auctions are everywhere and affect our daily lives.”
Efficiency and auctions
Auction theory is in charge of designing efficient allocations in auctions, understanding by this mechanisms that allow the goods to remain in the hands of the agents that value them the most and that the allocation is the least costly possible in terms of total resources.
There are two circumstances in which its study is especially relevant:
When the size of the market is small.
When the agents involved have information asymmetries that generate inefficiencies in the assignment.
The utility of the studies
The work of Wilson and his disciple Milgrom not only serves to understand how auctions work and why bidders behave in certain ways. They have also designed new auction formats for the sale of goods and services that have benefited both sellers and buyers around the world.
Based on the winner’s curse, that is, pay too much and lose (money), Wilson has studied why bidders tend to bid below their best estimate of common value. For his part, Milgrom has formulated a more general theory of betting that not only allows common values among different bettors to vary, but private values as well.
Games and auctions
Addressing the economic problem of auctions using the theory of non-cooperative games meant, at the end of the 1970s, a major change in economic theory. In particular, Milgrom and Wilson showed that there were several economic problems that could not be analyzed in the context of perfectly competitive markets; it was necessary to focus on the study of incentives and information, which provided a more realistic perspective of how the market works.
Among their many contributions, economists were the first to recommend (in 1994) the system of multiple simultaneous rounds, based on open bids in which each company can see what the others offer, instead of the system of closed envelopes that was applied in the concessions of radio and mobile licenses, and whose result was not good for any of the parties in the auction.
The system proposed by the future Nobels was clearly more efficient than the traditional model.