You might have come across auctions at some point in your life, either in movies or actually witnessed it somewhere. It is kind of funny to see how each bidder tries to outsmart the other one with their bids. At times, a game of ego also ensues to prove that one is capable of paying more, with the end result that items get heavily overpriced and the winning bidder pays much more than the actual cost of the item. What is the point in paying 10 times the price of an item to win it at an auction? Why would one do so?
There is a term called the ‘Winner’s curse’ which is used to depict this scenario of having won the bid but by paying much more than what the item is worth. Did you know one could even derive theories and postulates on auctions? And did you know that this year’s Nobel in Economical Sciences was awarded to Drs. Paul R. Milgrom and Robert B. Wilson for their contributions in understanding auctions.
Auctions are generally based on the fact that if you are a bidder you are inclined to buy the item at the lowest price possible and if you are the seller, you would want to sell it to the highest bidder of your item. How does one optimize auctions to yield maximal benefit and to predict outcomes? Is there a pattern involved and can formats be developed?
Researchers have been trying to understand the procedures of bidding and the different outcomes it can have and developed an auction format to understand the same. Analysis of this is based on what bidders know and what they don’t know but believe others to know.
Dr. Wilson developed a theory for objects with a common value which has an uncertain value during the auction but then in the end remains the same for all. This includes the future value for minerals in a given area.
Dr. Milgrom developed a theory of auctions that included not only the common values but also private values that may vary from bidder to bidder. For example, while the common value of an uncut diamond may remain the same, the private values may include the expertise, machinery available for cutting which could vary from bidder to bidder but can influence the price of the end product they would resell later at.
Their theories demonstrated that the outcome of an auction is dependent on the type of auction being conducted (open or closed bid) which would in turn govern the nature of the auctioneer and the way it is conducted, and on the common and private values involved.
While getting the highest price may be the objective for private sellers, public sellers like the government, etc may also consider the societal benefit as a key factor and thus set up margins within which the bidder may have to operate even after 
winning. These restrictions need not be profitable to the bidder all the time. Avoiding the Winner’s Curse is the objective, thus, of all bidders.
These theories developed have influenced many auctions and helped nations and economies to a great extent by aiding in a better understanding of the principles of successful auctions and developing auction formats.
It is not just physical items like antiques or precious items that are up for auctions these days. It is common to see mineral deposits, uncut diamonds, and even radio frequencies being auctioned in many countries.
“This year’s Laureates in Economic Sciences started out with a fundamental theory and later used their results in practical applications, which have spread globally. Their discoveries are of great benefit to society,” says Peter Fredriksson, chair of the Prize Committee.
A small trivia about this Nobel Prize in economics is that it is unlike the other five Nobel Prizes (Physics, Chemistry, Physiology or Medicine, Literature and Peace) this is sponsored by the Sveriges Riksbank, the Sweden’s central bank and not the wealth from Alfred Nobel’s will. Hence is officially known as The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. The figurehead of Nobel on the medal is also slightly different from the other Nobel medals.
The next time you witness an auction, either on television or in real life, remember that it is not just a simple process of raising the price and winning the object but also successfully deflecting the Winner’s curse…..
To know more on this, click:
https://www.nobelprize.org/prizes/economic-sciences/2020/press-release/
https://www.nobelprize.org/prizes/economic-sciences/2020/popular-information/
