Designing for fair competition: how auctions promote efficiency and neutrality

Auctions are a common way to allocate resources and determine prices. Nobel economist Robert Wilson studies how auctions promote fair competition, efficiency, and neutrality, and why they're an important tool for businesses and governments.

19 May 2023 5 min read
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Markets, which provide us the ability to trade goods and services with one another, are the bedrock of our economy. Yet, the question of how we should organize these markets is one that has preoccupied economists for decades. In the past, the answer was simple: supply equals demand. However, over time, economists have realized that the procedural rules of the market are just as important as supply and demand.

Nobel Laureate and economist Robert Wilson has spent much of his career studying auctions, which he believes are the most prominent form of market organization.

“The economy in general is this information system of telling people ‘Invest here, buy that’ and so on because they’re telling you how much something is worth,” says Wilson. “Auctions are the means by which price signals are formed. They are a set of rules that can be applied in almost any circumstance.”

“We're in an era where economists pay a lot of attention to the implementation, the details, the actual procedural rules of markets and how they're run,” Wilson continues.

This shift in focus is critical because it allows for a more nuanced understanding of markets and how they can be designed to promote fair competition.

Auctions are a set of rules that can be applied in almost any circumstance.

What are auctions and why do they work?

Auctions, whether they're used to sell a product or service, promote competition among potential buyers or sellers. This competition can lead to a more efficient allocation of resources, as Wilson explains. “If there's only one item to be sold and there are 10 people that want it, you want to assign it to the person that values it the most,” he says. “An auction is intended to elicit those values from those 10 bidders, and that enables us to assign it to the one that values it the most.”

How do you ensure an auction is fair?

Efficiency isn't the only concern when it comes to designing fair markets. As Wilson notes, it's also important to create a neutral forum for trade. “Of course, you could always design the market in some way to favor buyers or sellers or particular buyers or sellers and so on,” he says. “A lot of what we try to do in market design is to make it a neutral forum for trade without prejudice in one form or another.”

One way to create such a neutral forum is to use what Wilson calls a “double auction,” in which both buyers and sellers submit bids and offers. These bids and offers are then reconciled in a set of transactions, which helps to ensure that the market clears efficiently and fairly.

The devil is in the details when it comes to designing a fair market. “There's so much informational content in the price,” says Wilson. In other words, the price of a good or service isn't just determined by supply and demand; it's also influenced by a variety of other factors, such as the level of competition in the market, the quality of the product or service being sold, and the reputation of the buyer or seller.

A lot of what we try to do in market design is to make it a neutral forum for trade without prejudice in one form or another.

Can favoritism be fair?

Wilson says that while auctions, when designed efficiently, promote fairness, there are scenarios where the rules can be written to help promote more diverse participants within an auction.

“We had special auctions that were conducted that gave favoritism to minority owned businesses, Native American owned businesses, women owned businesses, or small businesses,” says Wilson. “The authorities set certain priorities. But in that case, they had separate auctions for these classes of bidders. They did not mix these preferential treatments with the standard auctions because then you can't really assure a fair auction for both classes of both parties at the same time.”

The design of an auction needs to balance the competing needs of promoting competition and ensuring fairness. As long as the rules are specified in such a way that they don’t depend on any particular participant's identity, resources, or opportunities then, according to Wilson, a little favoritism can in fact be fair.

With all these complexities, it's no surprise that market design is an area of ongoing research and debate among economists. However, one thing is clear: designing a fair and efficient market requires careful attention to detail and a commitment to neutrality and transparency.

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Can auctions guarantee fair competition?

Robert B. Wilson

Nobel Laureate, 2020

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