When you think of auctions, you perhaps imagine an arthouse like Sotheby’s selling famous paintings for hundreds of millions of dollars.
But auctions are much closer than you think. If your parents have bid on a collectible on eBay, or a weekend getaway package to support a local charity, they are participating in an auction as well.
These days, auctions determine everything from government contracts to housing prices, wifi bandwidths, and electricity bills that affect individuals. Paul Milgrom and Robert Watson, this year’s winners for the Nobel Prize in Economics, studied traditional models of auctions and came up with new formats that have benefitted governments and society at large.
Let’s look at the history and some fascinating concepts behind an auction.
Types Of Auctions
Did you know that auctions originated in Ancient Greece when women were auctioned off as brides?
There are several types of auctions today, of which the English and Dutch are the most common.
- English auctions start from a low price, which gradually increases until the one with the highest bid buys the item. In Dutch auctions, auctioneers start from a high price and lower it until a bidder is willing to buy the object.
- Auctions may have open bids in which all participants know how much the others are bidding. In a private bid auction, participants’ bids are sealed from one another such as in government contracts.
- Finally, auctions can include private or common value. For example, if you are bidding on a weekend getaway, how much you are willing to pay depends on the value you place on the vacation and hence, has a private value. Common value, on the other hand, refers to the value placed by everyone on the item. If you are bidding on a house, you want to be sure you can sell the house later, and hence its common value is important.
What Did The Winners Do?
Wilson analyzed common value auctions and a phenomenon known as “winner’s curse.” If some bidders have more access to information about the value of an object, they might stop overbidding if the price increases too much. This would lead to less revenue for sellers and the person who wins the bid may make a loss on the transaction (known as the winner’s curse).
Milgrom evaluated auctions with both private and common values. He found that in an English auction when buyers were able to see each other’s bids and had a sense of the value of the object, the role played by the winner’s curse was minimized.
Wilson and Milgrom then applied these ideas to maximize profits for governments. The U.S government had been struggling to make money auctioning radio frequency spectrum to companies that provide wireless services such as mobile phones and the internet. The economists came up with new formats that allowed multiple radio frequencies to be auctioned at the same time and included several rounds of bids.
This system is now used widely by different countries, including the UK, India, Canada, Spain, and others, and has produced more than $120 billion! Milgrom and Wilson have revolutionized auctions and helped better governments, companies, and taxpayers.
Sources: NobelPrize.org, NYTimes, Telegraph, TheConversation