Underlying carbon emission credits, electricity markets, and radio spectrum allocations is the humble and ancient sale format of the auction. This year’s Nobel Prize in economic sciences has been awarded to economists who pioneered auction theory and invented new formats that drastically shifted how public resources are allocated. The prize is shared by Paul Milgrom and Robert Wilson, both of Stanford University.
Before Wilson’s work in the 1960s and 1970s, research on auctions focused on each person’s private or subjective evaluation of the goods or services for sale. But underlying many auctions is a common value—a market price—that bidders share but must estimate independently. Wilson used game theory to establish the best bidding strategy in common value auctions, and showed how it leads to low bids as people try to avoid the “winner’s curse”—overestimating the common value and winning the auction at too high a price.
Milgrom, Wilson’s graduate student, added to this framework by showing how both private values and common values influence the auction outcomes. “They applied auction theory to more realistic settings,” Peter Fredriksson, an economist at Uppsala University and chair of the Nobel committee on economic sciences, said at the press conference. “Their basic research allowed them to invent entirely new auction formats.”
In the 1990s, the U.S. Federal Communications Commission put this theory to work to better allocate radio frequency bands to telecom and media companies. The agency previously allocated spectrum using licence applications and random lotteries. By using Milgrom and Wilson’s auction format, designed to counter the problems of uncertain values and the winner’s curse, the new FCC spectrum auctions drove billions of dollars in sales over the next twenty years.
The format has since been adopted by other countries—including the United Kingdom, India, and Canada—to improve their allocation of not just radio frequency bands, but also other assets like carbon emission allowances.