Demystifying the Auction System
The article “How Auctions Help Solve Some of the World’s Most Complicated Problems” takes a deep dive into Paul Milgrom and Robert Wilson’s study of auctions. The article was published on KelloggInsight, a platform that showcases the latest research by the Kellogg School of Management faculty. It talks about and goes beyond what we learned about auction theory in class. Specifically, it discusses Milgrom and Weber’s research and their practical applications.
An important concept in auction theory is the winner’s curse. It is the dilemma in common value auctions where the winner might have been the most optimistic about the value of an item and therefore could have potentially overpaid. Bidders aware of this curse would bid cautiously. This phenomenon can be seen in the bidding for drilling rights.
To mitigate this, Milgrom and Weber designed a framework where auctions had both elements of private and common value auctions resulting in the Linkage principle. This principle states that a seller can increase revenues by following a policy of open and honest revelation of any information regarding the quality of the item being sold. As discussed in class, in an English auction, more information is revealed in the course of the auction as bidders learn about each other’s valuations from the bids they observe. Therefore, reducing the problems associated with the winner’s curse.
This research also had real-world applications. For instance, the US government had found out that the Salomon Brothers were bidding illegally on Treasury securities in the 1900s to corner the market. To combat this, they applied Weber and Miligrom’s research to form a market design with lower susceptibility to manipulation and lower cost of financing. Another example is the sale of the radio spectrum to telecommunication companies by the Federal Trade Commission.
Recently, Milgrom also developed combinatorial auctions, where multiple objects being auctioned differ from one another. Here bidders are interested in a combination of packages. For instance, in a radio spectrum auction, bidders care about geographically adjacent spectrums. Verizon or AT&T would, for example, have to tie together the rights over certain geographical areas. Practically, a way to apply the research would be to start with a really high price and lower it until the market clears.
In the future, these methods can be used in various areas like search engines to sell ads.
Source: https://insight.kellogg.northwestern.edu/article/auction-theory-uses/amp