US auction theory pioneers win Nobel economics prize

Two American economists won the Nobel Prize for improving how

auctions

work, research that underlies much of today’s economy — from the way Google sells advertising to the way telecom companies acquire airwaves from the government.

The discoveries of Paul Milgrom and

Robert Wilson

, both of

Stanford University

, “have benefitted sellers, buyers and taxpayers around the world”,

the Nobel Committee

said. Wilson was once Milgrom’s PhD adviser, and the two also happen to be neighbours. Reached by phone at his home in California, Milgrom said he received news of their win “in a strange way”. “I got a knock at my door from Bob Wilson,” he said. The two men tackled the tricky problem of making auctions work efficiently.

Among the insights of the two Stanford University economists is an explanation of how bidders seek to avoid the so-called “winner’s curse” of over-paying, and what happens when bidders gain a better understanding of their rivals’ sense of value. Milgrom and Wilson notably came up with formats for selling interrelated items simultaneously.

Wilson showed that rational bidders tend to place bids below their own best estimate of what he called the “common value” — that is, when the value of an item is deemed to be the same for everyone — for fear of paying too much. Milgrom complemented that with theories on “private values”, when the perceived value of something differs from bidder to bidder. He demonstrated that an auction format will give the seller higher expected revenue when bidders learn more about each other’s estimated values during the bidding process.

In 1994, US authorities used one of their auction designs to sell radio frequencies to telecom operators. Milgrom and Wilson (with help from

Preston McAfee

, now at Google) designed an auction format in which all the licenses were sold in one go. That format discourages speculators from buying up frequencies in a specific geographic area and then reselling them to big telecommunications firms seeking to patch together national or regional networks. The auction raised $617 million — selling frequencies that previously were handed out for virtually nothing — and became a model for countries from Canada to India. The format has also been used to auction off electricity and natural gas.

The effects of their work can be seen all around. “Online advertising is sold at auction,” said

David Warsh

, who tracks economic research at his blog Economic Principals. “That Google was able to adopt the method so quickly and seamlessly depended entirely on theory developed by Milgrom and his competitors and their students.” Last year the honour went to India-born Abhijit Banerjee, French-American Esther Duflo, and American

Michael Kremer

for their work on alleviating poverty.