Unveiling Auction Theory

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Introduction to Auction Theory

Auction Theory is a discipline that studies the behaviour of bidders in auctions for the purpose of achieving market equilibrium while at the same time avoiding market failure. The field is closely linked to game theory and economics of asymmetric information. There are two fundamental problems that auction theorists try to solve:

  1. How can we maximise the revenues of the sellers/auctioneers?
  2. How can we ensure the items fall into the hands of buyers/bidders that value them the most?

The types of the products

In addition to the question, auction theorists also have to know the types of the auctions and the products. As far as products are concerned, there are two types:

  • Products with Independent Private Values (IPV)
  • Products with Common Values (CV)

The types of the auctions

Aside from the types of the products, there are four fundamental types of auctions that we usually consider. A more complicated type of auction is usually a variation of these four. The four basic types are as follows:

  • English Auction
  • Dutch Auction
  • First-Price Sealed Bid Auction
  • Second-Price Sealed Bid Auction

Mechanism Design

Here comes the interesting question. Okay, so we have these four types of auctions and two types of products. How will this help us in designing our auctions? How do we know which one of these is the most beneficial? While I want to give a firm and direct answer, I can’t. The reason is of course in real scenarios, there are multiple factors that we need to consider. In the spectrum auction for example, we need to consider bundling. Electromagnetic frequencies are not useful on their own. Most of the time they need to be combined/bundled before being auctioned. In light of this, the achievement of both Paul Milgrom and Robert B. Wilson in designing a set of rules that work for frequencies is indeed amazing and worthy of the prize!

  • The bidders are risk-neutral
  • The bidders have independent private values
  • The bidders are symmetric

Conclusion

And thus our short journey into the field of auction theory comes to an end. Hopefully this has been an interesting read and spark your interest about auctions. For those of you who are interested in knowing more about the work of both Paul Milgrom and Robert B. Wilson, do click on the following link: https://www.nobelprize.org/prizes/economic-sciences/2020/press-release/.

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