Congratulations to Paul R. Milgrom and Robert B. Wilson who were jointly awarded the
Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2020
« for improvements to auction theory and inventions of new auction formats. »
What is auction theory and why the laureates’ work is important?
Imagine a local government that would like to grant a concession to build a highway between two cities. The government has no means to build the highway on its own, and also has no idea what are the costs of building the highway. They decide to organize a procurement auction for construction companies and give the concession to the company with the lowest bid. The government would like to ensure that they pay the least amount of taxpayer money that gets the highway built properly. In addition, they would also prefer that the companies submit their true construction cost as their bid, and not a bid that has been biased by strategic speculations.
What is the auction format that would achieve these goals? Should the bidders submit their bids secretly; or announce them publicly, one by one? Should the winner be paid exactly their own bid, or the bid submitted by the company who got the second place? Maybe another specific amount?
These questions are not easy to answer. To find the correct procedure, the auction designer also has to consider the bidders’ perspective. How do the bidders formulate their bids based on their construction costs? What do the bidders think about their rivals’ costs? And what do they think about how their rivals formulate their bidding strategies?
The questions become even more complicated when multiple objects are auctioned at the same time, like in a radio frequency auction. The work of Paul Milgrom and Robert Wilson helps us to find the answers.
Economic theory often faces the critique of focusing on abstract problems that are disconnected from reality. It is also too often claimed that the rigorous yet elegant results are far from applicable to everyday economic problems. This is certainly not the case for auction theory. Its most important results – including the work of this year’s laureates – are used worldwide in the practical design of auctions for radio frequencies, electricity capacities and similar objects. The success of auction theory is a great example of how scientific breakthroughs – even theoretical ones – can benefit our society.