Context: Improvements to auction theory and auction formats by economists Paul Milgrom and Robert Wilson, have secured the pair the 2020 Nobel Prize in Economics.

• Last year the honour went to French-American Esther Duflo, Indian-born Abhijit Banerjee of the US, and American Michael Kremer for their experimental work on alleviating poverty.

About the winners

Paul R. Milgrom, born 1948 in Detroit, USA.

• Ph.D. 1979 from Stanford University, Stanford, USA. Shirley and Leonard Ely Jr. Professor of Humanities and Sciences, Stanford University, USA.

Robert B. Wilson, born 1937 in Geneva, USA.

• D.B.A. 1963 from Harvard University, Cambridge, USA. Adams Distinguished Professor of Management, Emeritus, Stanford University, USA.

About 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 and what outcomes are achieved.
• When one thinks of auctions, one typically imagines the auction of a bankrupt person’s property to pay off his creditors. Indeed, this is the oldest form of auction. This simple design of such an auction — the highest open bidder getting the property (or the commodity in question) — is intuitively appealing as well.
• But over time, and especially over the last three decades, 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.
• For instance, when selling telecom spectrum, a government could either think in terms of maximising its revenues or aim at making telecom more affordable to everyone. If it wants to maximise revenues, the auction has to be designed one way, but doing so will imply that the company eventually winning the contract will make telecom services costlier and, in the process, deprive the poorest sections of affordable telephony and Internet access. The up-side, however, is that the government will get more money in its kitty and can use it whichever way it likes — possibly even subsidise the telecom costs of the poorest.
• On the other hand, if the government’s goal is to enable the broader society to access the benefits of the telecom revolution and allow even the poorest to use the Internet at an affordable rate, it may want to focus more on how best a company can ensure that. In fact, before auctions became the norm for limited resources such as radio waves, governments used to allocate them as one would conduct a beauty contest. This would involve asking how a company might use the spectrum and assessing which company is best suited to receive the license. This approach, however, led to a proliferation of lobbying.
• But even when a beauty contest approach was replaced with an auction, it mattered how the auction was designed. For instance, if spectrum is auctioned at the regional level, national players may not get seamless access to optimum quality of spectrum across the country; as a result, they may not bid as aggressively. In the US, such a mistake led to a second-hand market where companies traded among themselves with little revenue accruing to the government.
• How an auction is designed, therefore, has a tremendous impact not just on the buyers and the sellers but also on the broader society.

Three key variables that determine the outcome of an auction

• One is the rules of the auction. Imagine participating in an auction. Your 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.
• 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.
• 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.

Key Points

• The new auction formats benefit sellers, buyers and taxpayers, all around the world, according to the Royal Swedish Academy of Sciences.
• New auction formats have been used for radio spectra, fishing quotas, aircraft landing slots and emissions allowances.

About Nobel Prize for Economics

• It is officially known as Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel. Unlike other prizes, the Nobel prize for Economics, was not created by the prize founder but was created by Riksbanken, the Swedish central bank, in 1968. 
• The first winner of prize was selected in 1969. As of now, 81 Nobel laureates in economic sciences have been awarded.
• The Prize amount: 10 million Swedish kronor, to be shared equally between the Laureates.