Auction Methods and Price Discovery

Definition of Auction

• An auction is a method of price discovery, determining what someone is willing to pay for an item and who gets it.
• Example: Selling a Coca-Cola to six interested buyers.

Purpose of Auctions

• Main purpose: Price discovery.
• Auctions are not needed for items with established prices and ample supply (e.g., shampoo).
• Auctions are more common for unique items where value is uncertain (e.g., paintings).

Types of Auctions

Oral Ascending Auction (English Auction)

• Description: Item is sold verbally, with bids increasing until no one is willing to bid higher.
• Common in movies; often starts with a minimum bid.
• Historical use dates back to the Babylonians.

Sealed Bid Auction

• Description: Bidders submit written bids in envelopes, opened simultaneously.
• High bidder wins, pays their bid (first price auction).
• Commonly used by governments to prevent collusion (e.g., at the Department of Justice).

Dutch Auction

• Description: Starts high and lowers the price until a bidder accepts.
• Known for tulip auctions in the Netherlands.
• Theoretically similar to sealed bid auctions; however, bidding behavior may differ in practice.

Second Price Sealed Bid Auction (Vickrey Auction)

• Description: The highest bidder wins but pays the second highest bid.
• Encourages bidders to bid their true value (e.g., eBay auction system).
• Introduces competitive pressure without requiring public bidding.

Comparison of Auction Types

• First Price vs. Vickrey Auction:
  • In a first price auction, bidders may lower bids to increase profit.
  • In a Vickrey auction, bidders can bid their maximum, as they pay the second highest bid.
• English auctions provide more information, leading to higher bids.
• Vickrey auctions have less price pressure but can lower the likelihood of losing money.

Real-Life Applications and Issues

• Example of Vickrey auction: New Zealand's telecom license auction resulted in a significant revenue discrepancy when using the Vickrey method.
• Sealed bid auctions may lead to less transparency but can still yield competitive prices.

Tips for eBay Success

• Monitor auction outcomes for similar items to understand price trends.
• If not in a hurry, track sales over time to determine a fair bid.
• Submit bids in multiple auctions to increase chances of purchasing at a lower price.
• Favor auctions with imminent expiration to receive quicker feedback on bidding.

Conclusion

• Auctions play a vital role in determining market prices for varying goods.
• Understanding different auction types aids in maximizing value in bidding scenarios.