The allure of the Auction Theory

Auction markets illustration

Paul Milgrom and Robert Wilson are the laureates for the Nobel prize for economic sciences this year. Their works on inventing new dimensions in regime of the auction theory.

Historically, a common auction method has been that of the sale by the fall of the hammer. In this method, people have always sold things to the highest bidder, or bought them from whoever makes the cheapest offer.

But this method has increasingly become rudimentary. New dimensions have arisen, and auction for goods and services for certain commodities, such as radio frequencies, has been difficult, because they are not able to be ingrained in the traditional way of auctions.

What is the psychology of the auction markets? Bidders behave strategically, based on the available information. They take into consideration both what they know themselves and what they believe other bidders to know.

In this mode, it becomes difficult to ascertain the value for auctions of objects with a common value, or where a value is uncertain beforehand but, in the end, is the same for everyone. Examples of such, include the future value of radio frequencies or the volume of minerals in a particular area.

In answering this dillema, Wilson, one laureate, showed why rational bidders tend to place bids below their own best estimate of the common value: they are worried about the winner’s curse – that is, about paying too much and losing out.

Over time, societies have allocated ever more complex objects among users, such as landing slots and radio frequencies. Therefore, expounding on the auction theory, is of great benefit to society.

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