295
See also: The competitive market 126–29 ■ Risk and uncertainty 162–63 ■
Social choice theory 214–15 ■ Game theory 234–41
Selling the spectrum
Auction theory came into
its own with a dramatic spate
of government auctions in the
US in the 1990s as industries
were privatized. The biggest
sell-off came when mobile
phone companies prepared
to pay huge sums for a share
of the electromagnetic
spectrum (the airwaves) on
which to transmit. The US
government wanted to
maximize its return, but it
also wanted to ensure that
the sale went to the bidder
who valued it most.
In 1993, the Federal
Communications Commission
(FCC) brought in auction
theorists to design the
auctions for the 2,500 so-
called spectrum licenses.
The telecom companies,
meanwhile, hired auction
theorists to design their bid
strategies. The FCC decided
on an English-style auction
but with a twist: the identity
of the bidders was kept secret
to avoid retaliatory bidding or
collusion to keep prices down.
The auctions broke all records,
and the approach has been
widely copied.fourth type of auction, similar to
the first-price auction, but in which
the winner pays as much as the
second-highest bid.
Using mathematics, Vickrey
proved that when bidders value
items independently, all four types
of auction yield the same revenue
for the seller, a discovery known
as “revenue equivalence theory.”
Shaded bids
Vickrey showed that it is better
for bidders to bid less than their
valuations, a strategy auction
theorists call “shading,” otherwise
they may end up paying over the
odds. Shading gained special
significance in the 1970s, when it
seemed that oil companies bidding
for offshore drilling rights often
ended up paying far too much.
Auction theorists discovered the
phenomenon of the “winner’s
curse:” an item goes to the
bidder who overvalues it the
most. Imagine that you submit a
successful bid of $100 for a picture.
You win because your bid is higher
than all the others. Suppose the
next highest bid had been $98. You
could have bid lower—$98.01—and
still been successful. In general the
winning bidder pays “too much,”
in this case to the tune of $1.99.
Auction theory can be used
to design auctions that maximize
the seller’s revenue and ensure that
the good goes to the buyer who
values it most. The success of
the US government’s spectrum
auctions in the 1990s (see box,
right) created a buzz about this new
area of economics. For many it was
proof that game theory was not just
theory but really did apply in actual
markets. Others insist that auctions
are a special type of market, and
that even they might not be fully
explainable using game theory.
What does seem true is that
auctions have now expanded well
beyond their traditional domains
of government procurements and
public bond sales. ■CONTEMPORARY ECONOMICS
In an auction there is a danger that
the winning bid will come from a
bidder who has overvalued the item,
a misfortune known as winner’s curse.
In Dutch auctions, as used in
Holland’s Aalsmeer flower market,
the price starts high and then begins
to drop. The first bidder to stop the
price as it drops takes the flowers.
$90
$100
$98