Oct 15, 2020 - Economy & Business

The importance of the auctions invented by the winners of the Nobel Prize in economics

Illustration of a scientist pointing to a blackboard with a gavel drawn on it

Illustration: Sarah Grillo/Axios

Economics is disparaged as "the dismal science" for good reason. And governments are rarely upheld as paragons of efficiency. But Paul Milgrom and Robert Wilson, the winners of this year's Nobel Prize in economics, have helped governments around the world create hundreds of billions of dollars of value with an astonishing level of sophistication and efficiency.

Why it matters: The auctions designed by the winners of this year's prize were initially used to allocate electromagnetic spectrum for cellphone communication. Since then, they've been used to price everything from airport landing slots to carbon-emission credits, in a manner that is fair, efficient, and effective.

The big picture: While auctions have been around for millennia, the two standard mechanisms — English auctions, where the price rises until there's only one bidder left, and Dutch auctions, where the price falls until a bidder emerges — can sometimes be unfair or inadequate.

  • For example: If two identical items are auctioned successively, they can often sell for very different prices. Or if a certain bidder values a certain combination of items while not particularly wanting any one on its own, it's hard to put together a good bidding strategy.

Between the lines: While nearly all auctions attempt to create as much value as possible by assigning an object to the buyer who can make the best use of it, government auctions also have to ensure they don't create monopolies or other market distortions.

  • The laureates' inventions, including the Simultaneous Multiple Round Auction, helped solve all of these problems — and also raised hundreds of billions of dollars that would otherwise have to have been levied in taxes.

Be smart: You trigger state-of-the-art auctions almost every time you visit a website. Most online advertising these days is sold via real-time bidding, which means that the ad is sold after you navigate to the page in question. Advertisers bid on reaching your particular eyeballs, reading your particular device.

  • Milgrom is involved in those auctions, too, theorizing how best to structure them and proposing a “modified second bid” design as the best way to maximize efficiency.

The bottom line: For most of the Cold War, governments would use game theory mainly for national defense. Auction design and strategy, which is a subset of game theory, is not only more socially useful than mutual assured destruction, it's also more socially useful than nearly everything else in economics.

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