Auction Theory

Auction Theory

Who hasn’t won the bidding on an item on eBay only for the elation of winning to be quickly replaced with the suspicion you paid too much.

That fear is more than just a fleeting emotion for compulsive eBay shoppers. It can affect entire markets that are dependent on potential buyers bidding for products including machinery and equipment.

This fear by bidders of overpaying at auction has a name – it is called ‘the winners curse’ a term derived for a psychological trait that sees potential buyers of say machinery and equipment at auction bid less than true value out of a fear of overpaying.

In an auction, objects can have a shared, common value for all bidders (such as a commodity) or private values that vary between bidders (such as machinery or equipment).

It was such a serious problem that two American economists, Paul R. Milgrom and Robert B. Wilson, were awarded the 2020 Nobel in economic science for improving auction theory and devising new auction formats. Milgrom devised a theory to deal with that mix of common and private value. He also found that the ‘winners curse’ was not much of a factor when prices start low and bid up than if they start high.

Auction theory has been used to great effect in complex situations such as allocating respirators early in the Covid-19 pandemic through to other auctions of products and objects including as machinery or equipment.

Nobel laureate Alvin E. Roth described the two men as “some of the greatest theorists living in economics today”. “They haven’t just profoundly changed the way we understand auctions — they have changed how things are auctioned,” he said.