The role of auctions in allocating public resources

Staff research paper

This paper by Chris Chan, Patrick Laplagne and David Appels was released on 20 February 2003. The paper provides an economic framework with which to consider the effectiveness and imitations of auction markets in allocating public resources.

It links auction outcomes to bidders’ behavioural characteristics and to the lack or imbalance of information available to governments and bidders.

The analysis covers the key elements of an auction, including the auction form, the auction environment, the bidding behaviour and the implications for allocative efficiency and revenue.

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Key points
Media release
Contents

Governments in Australia and elsewhere increasingly recognise the potential of auctions as a policy tool for allocating public resources.

Well-designed auctions can promote efficient allocation of resources without requiring governments to have prior knowledge of resource values or costs. Compared with administrative allocations, auctions are more transparent and less dependent on officials' subjective judgment, and can yield greater revenues or cost savings for governments.

Success of government auctions depends on having a thorough understanding of bidding behaviour and paying close attention to auction design. Simple auction forms can cope with a simple environment but may not apply generally.

Auction theory provides a framework for developing practical design guidelines. Individuals competing for public resources often have the incentive and ability to misrepresent resource values or costs. Auction design is about devising bidding rules to address such incentive problems and their implications for revenue and allocative efficiency.

Public funds for conservation activities can be allocated through an auction in which landholders compete on compensation, land areas conserved and site-specific conservation benefits. In this application, auction design involves the following issues:

how to realise synergies from conserving adjacent lands that belong to different landholders
how to minimise disbursements
how to use information on conservation benefits in selecting bids.

In auctioning rights to use radio-spectrum, bidders should be allowed to combine spectrum lots in the most efficient way. Synergies exist in the use of spectrum in Australia. This finding strengthens the case for package bidding in spectrum auctions.

Background information

Patrick Jomini (Assistant Commissioner) 03 9653 2176

Governments are increasingly recognising the potential of auctions as a tool for allocating public resources. Spectrum licences, conservation funds, pollutant emission permits, power supply contracts and water rights have now been allocated at auction.

Productivity Commission researchers, in a paper released today, show that auctions can assign resources to those best able to use them; they are more transparent and less subjective than administrative allocation. Effective use of auctions in the public sector, however, depends on understanding auction design and its implications for pursuing policy goals.

The staff research paper, The Role of Auctions in Allocating Public Resources, provides a primer and overview of auction theory to assist governments in using this tool. It includes two case studies that illustrate specific design issues in auctions of conservation contracts and spectrum auctions.

Background information

Patrick Jomini (Assistant Commissioner) 03 9653 2176

02 6240 3330

Preliminaries
Cover, Copyright, Contents, Preface, Overview

1 Introduction
1.1 Auction design matters
1.2 Scope of the paper
1.3 How to read this paper

2 What is an auction?
2.1 Auctions as a market mechanism
2.2 Auctions as a policy tool

3 Basic auction forms
3.1 Bidding as a strategic decision
3.2 Auction environments
3.3 Auction forms
3.4 Revenue equivalence theorem
3.5 Outcome properties
3.6 Auction design for increasing revenue
3.7 Lessons from a formal analysis of auctions

4 Auction design issues
4.1 Bidders' interdependent valuations
4.2 Bidders' risk attitudes
4.3 Bidder collusion
4.4 Bidder participation
4.5 Selling multiple items
4.6 Conclusion

5 Auctions of conservation contracts
5.1 The nature of conservation contracts
5.2 The role of auctions in environmental management
5.3 Government auctions of conservation contracts
5.4 The contracting of numerous landholders
5.5 Bidding on price and service quality
5.6 Conclusion

6 Synergies in spectrum auctions - the Australian case
6.1 Spectrum auctions worldwide
6.2 Synergies and licence aggregation
6.3 Spectrum auctions in Australia
6.4 Indirect evidence of synergies
6.5 Econometric estimation of synergies
6.6 Conclusion

A Enhancing market competitiveness
A.1 Adjusting market values for externalities
A.2 Promoting market entry
A.3 Creating competitive markets

B Spectrum auctions
B.1 Multi-item auctions
B.2 Simultaneous ascending auctions in practice
B.3 Experimental evaluation of auction designs

References