Two American economists won the Nobel Prize on Monday for improving how auctions work, research that underlies much of today's economy — from the way Google sells advertising to the way telecoms companies acquire airwaves from the government.
The discoveries of Paul R. Milgrom and Robert B. Wilson, both of Stanford University, "have benefitted sellers, buyers and taxpayers around the world," the Nobel Committee said.
Wilson was once Milgrom's Ph.D. adviser, and the two also happen to be neighbors. Reached by phone at his home in California, Milgrom said he received news of their win "in a strange way."
"I got a knock at my door from Bob Wilson" when it was still the middle of the night, he told The Associated Press.
Milgrom, 72, said students, friends and colleagues had long suggested he and Wilson, 83, might be due for the prize.
"It's nice to have their respect but their affection as well," Milgrom said.
The two men tackled the tricky problem of making auctions work efficiently. The committee said Wilson's work showed "why rational bidders tend to place bids below their own best estimate of the common value" — which could mean the item goes for less than it's worth and perhaps not to the buyer who most wants it, neither of which is supposed to happen if the auction is working properly.
The effects of their work can be seen all around. "Online advertising is sold at auction," said David Warsh, who tracks economic research at his blog Economic Principals. "That Google was able to adopt the method so quickly and seamlessly depended entirely on theory developed by Milgrom and his competitors and their students."
The work is about more than money. Some governments, for example, auction off the right to pollute in hopes of reducing emissions; cleaner companies can resell unneeded rights to dirtier ones, creating a financial incentive for companies to make their operations greener. "The objective is not always to maximize the revenue for the seller but also can have a societal objective," said Nobel Committee member Ingrid Werner.
One problem for sellers in auctions is the so-called winner's curse. If buyers are vying to purchase, say, fishing rights, they have to make bids without knowing what the price of fish will be in the future. They begin to worry that they will only prevail by overpaying, and they can respond by scaling back their offers.
A solution, Wilson and Milgrom's research showed, is for the seller to provide as much information as possible before the bidding begins, perhaps providing an independent appraisal of the item being sold.
They also tackled the "snake in the grass strategy," Wilson said. This involves a company keeping its interest in the item being sold secret for most of the auction and then making the winning bid at the last minute.
"It's like sniping an eBay auction," Wilson told the AP, adding that they designed rules that force bidders to reveal their interest earlier on.
Their research has had a big impact on the telecommunications industry, where private companies seek licenses from the government to use publicly owned radio frequencies for everything from mobile phone calls to internet payments.
Before the 1990s, the U.S. government essentially conducted "beauty contests" to hand out the frequencies, letting companies make their case for getting the licenses. The approach encouraged aggressive lobbying but didn't raise much money for the Treasury.
In 1994, the U.S. government turned to auctions. Milgrom and Wilson (with help from Preston McAfee, now at Google) designed an auction format in which all the licenses were sold in one go. That format discourages speculators from buying up frequencies in a specific geographic area and then reselling them to big telecommunications companies seeking to patch together national or regional networks.
The auction raised $617 million — selling frequencies that previously were handed out for virtually nothing — and became a model for countries from Canada to India. The format has also been used to auction off electricity and natural gas.