Economic theory was used in designing the "simultaneous ascending auction," which was introduced in 1994 to sell U.S. radio spectrum licenses. But in designing real auctions there are important practical questions for which current economic theory offers no answers.
Milgrom discusses how economic theory was used in the design and improvement of the "simultaneous ascending auction," developed initially for the sale of radio spectrum licenses in the United States in 1994. Efficiency of allocation was the statutory goal.
Much attention to the auction came from its role in reducing federal regulation of the radio spectrum and allowing market values, rather than administrative fiat, to determine who would use the spectrum resource. Observers were also fascinated by the large amounts of money involved and the auction's extensive reliance on Web-like information technology.
The first use of the auction rules resulted in a $617 million sale of 10 paging licenses in July 1994. In the broadband PCS auction, which began in December 1994, 99 licenses were sold for about $7 billion. After these auctions it became difficult to ignore the tremendous value of the large amounts of spectrum allocated to uses—such as high-definition television—for which Congress had demanded no compensation. Perceived success with the new rules inspired similar spectrum auctions in countries around the world.
Milgrom analyzes some of the auction's capabilities and inherent limitations, the roles of various rules, the possibilities for introducing combinatorial bidding, and some considerations in adapting the auction for sales with a revenue goal. Drawing on both traditional and new elements of auction theory, he concludes, theorists have been able to analyze proposed designs, detect biases, predict shortcomings, identify tradeoffs, and recommend solutions.
But in designing real auctions there are important practical questions for which theory currently offers no answers. The "bounded rationality" constraints that limit the effectiveness of the generalized Vickrey auction have so far proved particularly resistant to simple analysis. Because of such limits to our knowledge, auction design is a kind of engineering activity. It entails practical judgments, guided by theory and all available evidence, but it also uses ad hoc methods to resolve issues about which theory is silent. As with other engineering activities, the practical difficulties of designing effective real auctions themselves inspire new theoretical analyses, which appear to be leading to new, more efficient, and more robust designs.
This paper—a product of the Private Participation in Infrastructure Division, Private Sector Development Department—is part of a larger effort in the department to study issues arising from private participation in infrastructure. The study was funded by the Bank's Research Support Budget under the research project "Auctions in Infrastructure" (RPO 682-58). Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Sandra Vivas, room Q7-005, telephone 202-458-2809, fax 202-522-2029, Internet address svivas@worldbank.org. The author may be contacted at milgrom@stanford.edu. (25 pages)
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