How Auctionomics Can Increase Your Profit ! UPSC
Reinventing auctions for the real world
WHY IN NEWS:
What did this year’s Nobel winners for economics discover about auction theory?
SYLLABUS COVERED: GS 3: Economy : Recent Developments
For PRELIMS go through the theories and principles in this article . Auction theory is a potential question . Questions can be easily framed from such topics .
For MAINS start with what is auction theory ? Impact and Comparison should suffice you preparation .
NOBEL PRIZE IN ECONOMICS
- This year’s Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded to Dr. Milgrom and Dr. Wilson.
- The duo were awarded “for improvements to auction theory and inventions of new auction formats”.
- They also played a crucial role in implementing their ideas.
WHAT IS AUCTION THEORY?
- Auction theory is a branch of economics that deals with, as the name suggests, auctions.
- The allocation of scarce resources, in turn, matters to economists because there is a limited supply of resources on earth.
- When compared to unlimited human needs, and hence they need to be allocated only to the most urgent needs of society.
In particular, auction theory deals with:
- The various ways in which auctions can be designed to improve seller revenues.
- How to increase benefits to consumers, or even achieve both these goals at the same time.
HOW IS IT RELEVANT?
- Throughout history, countries have tried to allocate resources in various ways.
- Some have tried to do it through political markets, but this has often led to biased outcomes.
- Think of how the rationing of essential goods worked in various State-controlled economies.
- People who were close to the bureaucracy and the political class came out ahead of others.
- Auctions, for a good reason, have been the most common tool for thousands of years used by societies to allocate scarce resources.
- When potential buyers compete to purchase goods in an auction, it helps sellers discover those buyers who value the goods the most.
- Further, selling goods to the highest bidder also helps the seller maximise his or her revenues.
- So, both buyers and sellers benefit from auctions.
WHAT ARE ITS APPLICATIONS?
- Auctions happen almost everywhere in the modern world.
- Even the sale of groceries in retail stores is based on an auction, albeit an implicit one that is relatively slow to adjust to changing market conditions.
- For instance, a supermarket manager, just as an auctioneer, tries to price his goods based on how much of it is sold during a certain day, week, or month.
- If another product fails to sell as fast as expected, its price may be lowered in order to clear any unsold inventory.
- More sophisticated and explicit auction mechanisms are used in the allocation of capital goods such as spectrum and minerals.
- But whether it is the auction of spectrum waves or the sale of fruits and vegetables, auctions are at the core of allocation of scarce resources in a market economy.
WHAT ARE THE ECONOMISTS’ CONTRIBUTIONS?
- To understand Dr. Milgrom and Dr. Wilson’s contributions, it is important to take note of the criticisms levelled against auctions.
CRITICISM – WINNERS CURSE
- The most common one is that auctions can lead buyers to overpay for resources whose value is uncertain to them.
- Researchers found that rational bidders may decide to underpay for resources in order to avoid the ‘winner’s curse’.
- Thus, argued that sellers can get better bids for their goods if they share more information about it with potential buyers.
REVENUE EQUIVALENCE THEOREM
- Dr. Milgrom added further nuance to this analysis by arguing that individual bidders may still submit vastly different bids due to their unique circumstances.
- A company that can sell oil at a higher price or process it at a lower cost, for instance, may be willing to pay more for crude oil.
- The auction format, in other words, did not matter.
- But Dr. Milgrom showed that the auction format can actually have a huge impact on the revenues earned by sellers.
CASE STUDY : SPECTRUM AUCTION
AUCTIONS GONE WRONG
1.NEW ZEALAND : In what is called a ‘Vickrey auction’, where the winner of the auction is mandated to pay only the second-best bid.
2.HOLLAND : Dr. Milgrom showed how Dutch auctions, in which the auctioneer lowers the price of the product until a buyer bids for it, can help sellers earn more revenues than English auctions.
- In the case two , the price rises based on higher bids submitted by competing buyers.
- Dr. Milgrom and Dr. Wilson, however, are most popular for their contribution towards devising new, real-world auction formats.
- The combinatorial auctions designed by the duo, used to sell complex goods such as spectrum as bundles, instead of as individual units.
- Earlier, governments sold spectrum rights on a piecemeal basis, which made it unappealing to companies which demanded spectra in a bundle.
- This led to private speculators earning billions in the secondary market by reselling spectrum.
- While the government was starved of revenues that it could have easily earned with better auction design.
HOW DO THESE CONTRIBUTIONS MATTER?
- The contributions of Dr. Milgrom and Dr. Wilson have helped governments and private companies design their auctions better.
- This has, in turn, helped in the better allocation of scarce resources and offered more incentives for sellers to produce complex goods.
- They argue that while enthusiastic bidding may lower the returns earned by companies, it will not necessarily lead to higher prices for consumers, as is commonly believed.
- This is because in any competitive market, pricing of consumer goods is based on what the market will bear, rather than on sunk costs.
- Further, persistent overbidding is unlikely as financial losses weed out inefficient speculators over time.
SOURCES:THE HINDU | How Auctionomics Can Increase Your Profit ! UPSC