the theory of games helps us to see what our best options are when we Face a strategic decision auctions are one place where people often think about what their best strategy is for bidding but economists have some surprising answers for them there are four common types of auctions the English auction is probably the type you think of when you think about auctions this is an open outcry auction in which the price increases until there's only one standing bid that bidder wins the item and pays the bid so they start the bidding low and people just shout bigger and bigger numbers until no one outbids the highest bidder and that bidder wins for the amount they bid the Dutch auction is the reverse it's an open outcry auction in which the price decreases until a bidder stops the auction that bidder wins the item and pays the bid so they start the bidding really high and everyone is silent then the auctioneer slowly lowers the price down until someone jumps up and says they will pay that price and then they win the item and pay that price then there are sealed bid auctions those are auctions where bidders privately submit bids at the same time the winner of the auction is whomever submitted the highest number but there are two ways to resolve what they pay in a sealed bid first price auction the highest bidder pays what they bid in a sealed bid second price auction the highest bidder wins but they pay the amount of the second highest bid which means they get a little discount let's evaluate the best strategies for these auctions let's say there are four potential buyers Tony Spencer Wu and Tasha Tony is willing to pay 500 for this item Spencer is willing to pay 450 Wu is willing to pay 300 and Tasha is willing to pay 250 dollars let's add another twist and say everyone knows these numbers this isn't as uncommon as it would seem businesses often bid for licenses or quotas and it's easy to tell how much they're worth to each company bidding based on the profit they would make from them and often people have a sense of what other people are willing to pay no matter which auction we have Tony will win so long as he's strategic about it he is the he's the one who's willing to pay the most so he's willing to outbid everyone else in an English auction he will walk away with the item for about 450 maybe a little more if Spencer gets the 450 bid in first but Tony doesn't need to pay 500 just a little bit more than Spencer in a Dutch auction Tony wins the item for about four hundred and fifty dollars also he knows Spencer will stop the auction there so he'll stop it just before what should Tony write down for his sealed bid if it's a first price sealed bid he needs to be strategic about it and bid slightly over Spencer's amount uh and so he'll win the item for about 450 maybe a little bit more but in a second price seal the bed Tony can write down 500 and he'll still only pay about 450 dollars for it as that will be the second highest bid this leads us to the revenue equivalence theorem under certain assumptions the four auction types are expected to raise the same revenue and the reason this matters is because this is the efficient outcome it is Pareto optimal for Tony to win the item and pay 450 but when we think about the Strategic Behavior we can see that Tony is probably less stressed with an English auction or a sealed bid second price auction he doesn't need to actually know the second highest bid to get the efficient outcome there we can see this when we think about what happens if the bidders don't know what everyone else is willing to pay in the English auction Tony still wins for about 450 dollars because that's where you outbid Spencer and no one outbids him in the Dutch auction though Tony doesn't know if someone's willing to pay 499 dollars and so his best strategy is to stop the auction at five hundred dollars and with a sealed bid Tony's best strategy is to write down his willingness to pay of five hundred dollars for the first price auction he will end up paying about five hundred dollars for it but the second price auction will see him pay 450 dollars looking at this we can see that if you're the auctioneer you prefer the Dutch auctions and first price sealed bins if you're the bidder you prefer English auctions and second price sealed bids that's why popular auction sites like eBay use the second price sealed bid format their goal is to attract buyers to the site and buyers will prefer the second price format but when you go to a fundraiser they'll often use the first price sealed bid because they want to get the most donations they can anyway I hope you take some time to think about the parts of your life that can benefit from Game Theory and strategic thinking and apply some of what we learned here it can end up changing your life