Nobel Prize in economics awarded to duo for work on auction theory

Paul Milgrom and Robert Wilson, professors at Stanford University, have won this year’s Nobel Prize in economics for their work on auction theory and the design of new auction formats.

The committee awarding the prize — officially known as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel — said the theory they developed had been instrumental in developing new and complex auction formats now used around the world, for purposes ranging from the sale of radio spectrum to allocating airport landing slots and setting up emissions trading systems.

Auction outcomes matter — for taxpayers as well as private buyers and sellers — because they influence so many aspects of daily life, from the price of electricity or government bonds to the quality of mobile phone coverage and smooth running of refuse collection.

Understanding how auction formats will influence outcomes is difficult, however, because bidders behave strategically, based on both the information they have and on what they believe other bidders know.

The prize committee said the laureates’ work had been “of great benefit to society”, allowing regulators and governments around the world not only to maximise revenues or procure at lowest cost, but also to put activities into the hands of agents best placed to manage them.

“It is a wonderful choice,” said Paul Klemperer, a professor at Oxford university and a leading figure in the same field. Mr Wilson was seen as “the father figure of practical auction design”, and had encouraged a generation of students, Mr Milgrom among them, he said.

Mr Milgrom, while best known for his work on auctions, would be a “hugely influential figure” even without this for his contribution in other areas, such as industrial economics and game theory, he added.

Mr Wilson, born in Nebraska in 1937, developed a theory for auctions of objects with a common value, which is uncertain beforehand, but the same for everyone — for example, a raw diamond where dealers’ views on the likely resale value will determine their willingness to pay.

He showed why bidders often placed bids below their own best estimate of the common value: because they were worried about the “winner’s curse” of overestimating this common value and overpaying.

Mr Milgrom, born in Detroit in 1948, formulated a more general theory of auctions that allowed for both common values and private values that vary from bidder to bidder — for example, where a house has a certain resale value, but suits some more than others to live in.

This showed that the seller would realise a higher price if the auction was conducted in a way that allowed bidders to learn more about each others’ estimated values during the process.

One of the pair’s best-known contributions was their joint work in designing the process for the first US auction of radio frequencies to telecom operators, in 1994. This was a challenge because operators did not know how much the licence for one geographical area was worth to them until licences for all areas were allocated.

Mr Milgrom and Mr Wilson invented a new format known as the Simultaneous Multiple Round Auction which involved offering licences for all geographical areas simultaneously, starting with low prices and allowing repeated bids — a format that became a staple method used for spectrum auctions in many countries over the following decades.

Mr Milgrom was also one of those involved in developing an elaboration of this format — the Combinatorial Clock Auction — which allows bidders to place bids on a package of objects or licences, which might be worth more to them than the sum of the components.

The committee said the two laureates were unusual in having developed both the theory and the applications of their research, with auctions gaining in practical importance as governments increasingly used them to distribute assets such as electricity and natural resources.

Speaking to reporters after the prize was announced, Mr Wilson said he could not recall participating in any auction other than an eBay purchase of ski boots, but that auctions were now ubiquitous, underlying every advert that appeared on an internet search engine.

Nonetheless, the committee’s choice marks a return to more traditional terrain after last year’s award went to the development economists Esther Duflo and Abhijit Banerjee, best known for their painstaking empirical research, rather than for theoretical breakthroughs.

Mr Klemperer said auction theory was to economics “like the fruit fly” to biologists — the perfect subject for laboratory research because the simple structure of an auction made it a good place to test and developed broader ideas about competition and game theory.

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