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Going once - going twice - the last of the 2020 Nobel Prizes is gone.
This year’s Nobel in Economic Sciences has been awarded to Stanford professors Paul Milgrom and Robert Wilson for their revelations about auction theory.
Note to reader: if at any point you get lost or bored, think back to A Beautiful Mind.
Experts in game theory, Milgrom and Wilson won the Nobel for creating mathematical models that promote “improvements to auction theory and inventions of new auction formats.”
In plain English - the pair helped better-answer one of the most basic questions in economics: who should get "the goods" and at what price?
One key problem the pair tackled is the so-called "winner's curse," or the reality that the winning bid in an auction tends to exceed the intrinsic value of an item. To compensate for this reality, most rational bidders will place bids below their best estimate of intrinsic value to avoid overpaying.
The Solution: might sound pretty basic.
- Milgrom and Wilson discovered that providing more information about the value of an item, such as an independent appraisal or certificate of authenticity, can help generate better auction outcomes.
- In addition, auction structures that allow bidders to learn about rival bidder's perceived values also lead to better outcomes. For instance, English auctions (where the price starts low and is bid upward) are better at avoiding the winner’s curse than Dutch auctions (where the price starts high and is bid downward).
Why It Matters
The insights of Milgrom and Wilson have been applied in a wide variety of use-cases, from airport slot auctions to Google's IPO.
Spectrum Use Case: Before the 1990s, the U.S. government doled out radio frequencies to telecom companies through lotteries or "beauty contests," which inspired aggressive lobbying but didn't generate significant proceeds for taxpayers.
In 1994, the FCC deployed Wilson and Milgrom’s “simultaneous ascending auction” to sell spectrum and the first auction generated $617 million. The technique has since been rolled-out worldwide and has generated more than $120 billion in proceeds.
- Critically: The advanced auction designs can help governments maximize revenues, but also help telecom providers avoid over-paying (and subsequently over-charging consumers for phone service).
The Takeaway: The Stanford professors will share the 10 million kronor ($1.1 million) prize for their work.