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Hey everyone! This is Navya and welcome back to Eco decode, your go to podcast for economics concepts simplified in just 5 minutes. Today we will continue our series: Nobel Prize Economics explained. We’ve gone over the 2023 Nobel prize in economics and the 2022 prize in Nobel prize in economics. Now, it is time to go further back in our time machine. 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".
Auctions are a concept that most of us are pretty familiar with. An auction is like a game where people can buy or sell things. To participate, you can make an offer (bid) for the item you want to buy, or you can propose the lowest price you're willing to sell it for. After everyone makes their offers, the item goes to the person who offered the highest price to buy the item, depending on the type of auction.
Every day, auctions involve the exchange of extremely valuable items, art, and antiques, but also things like securities, minerals, and energy resources. These items can be worth a tremendous amount of money. Even the IPL teams are selected through an auction process! Today, financial securities like government bonds are often sold using auction methods similar to those used in ancient times. Governments now use auctions to sell rights to natural resources like timber, minerals, and petroleum, as well as radio frequencies. Additionally, they use auctions to buy various goods and services from private companies.
There are two types of values that can be assigned to products in an auction: private values and common values. The private-values assumption is that each bidder's valuation is solely based on their own individual preferences or needs for the item being sold. However, in reality, values are often influenced by others, creating interdependencies. When there are interdependencies, a bidder might want to change their own estimate if they find out what another bidder values the item at. These are common values.
Today’s Nobel laureates tried to further our knowledge of how auctions work and how they can be improved. They answered the questions, “how are bidders likely to behave for a variety of auction formats and under different informational conditions”. According to the prize committee, Mr. Wilson was the first person to come up with a system for auctioning items that have a common value. In his research, he found that bidders tend to offer less than what they believe the item or service is actually worth because they fear paying too much (known as the winner's curse), especially when they lack important information about the item.
Mr. Milgrom developed a theory to handle situations where items have both shared and individual values. He also studied how the "winner's curse" affects these situations. He discovered that people tend to bid too low in English auctions, where prices start low and increase, compared to Dutch auctions, where prices begin high and decrease.
The most famous contribution of the pair is their work on creating new auction formats for complicated situations. One of these formats is the method used by governments to assign radio frequencies to telecom operators. In the past, radio bandwidth was distributed through "psuedo contests" where operators tried to persuade authorities to give them the rights, leading to lots of lobbying. In the 1990s, there was a change to a lottery-based system for allocating bandwidth, but it didn't work well initially. The lotteries were done locally, causing issues like fragmented networks for national operators. Then, Mr. Milgrom and Mr. Wilson came up with a new way to auction the radio spectrum. Their approach allowed many different areas of the radio spectrum to be auctioned off to various bidders at the same time. It started with low prices and allowed bidders to make repeated offers. This new method was adopted by the Federal Communications Commission (FCC) in 1994, and it turned out to be much better. It not only efficiently distributed radio space but also generated significantly more money for the government. This is called the ‘Simultaneous Multiple Round Auction’
They have also assisted in bringing together the study of various trading systems, showing us how auctions are closely connected to trading through markets with fixed prices or other negotiation methods. And now you know how Paul R. Milgrom and Robert B. Wilson contributed to a massive improvement in our knowledge of auctions.
See you in the next episode!
Works Cited
McAfee, Preston. “Scientific Background on the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2020.” Nobel Prize, 12 October 2020, https://www.nobelprize.org/uploads/2020/09/advanced-economicsciencesprize2020.pdf. Accessed 23 July 2023.
“The Prize in Economic Sciences 2020 - Scientific Background - NobelPrize.org.” Nobel Prize, https://www.nobelprize.org/prizes/economic-sciences/2020/advanced-information/. Accessed 23 July 2023.
Smialek, Jeanna. “U.S. Auction Theorists Win the 2020 Nobel in Economics (Published 2020).” The New York Times, 12 October 2020, https://www.nytimes.com/2020/10/12/business/nobel-economics-paul-milgrom-robert-wilson.html. Accessed 23 July 2023.