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Nobel Prize in Economics

  Oct 20, 2020

Nobel Prize in Economics

Q. Why in news? 

Q. What is auction theory?

Q. What are the key variables that determine the outcome of an auction?

Three key variables need to be understood while designing an auction.

  1. 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.
  2. 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.
  3. 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.

Milgrom and Wilson have done pioneering work on auction theory and much of our current understanding is due to their research.

As the Academy notes, “Wilson developed the theory for auctions of objects with a common value — a value which is uncertain beforehand but, in the end, is the same for everyone”. Wilson showed what the “winner’s curse” is in an auction and how it affects bidding.