ECONOMICS AND BIDDING A first price sealed bid auction is the market establishment where the higher bidder

in an auction gains ownership of the item that is auctioned, and the price paid for the item is equal to the price of the highest bid. This is different from second price sealed auctions in the sense that in that in this case, the high bidder purchases the auctioned item at the amount equal to the second highest bid. There is a distinction between a real time auction and sealed bid auction. Real time auctions which are known as English oral auctions go ahead with a bid if it meets the requirements of being higher than that of a standing bid and in turn, the last bid is the one that wins. This is also known as an increasing price auction. On the other hand, a decreasing price auction, known as Dutch oral auctions target the first and only bid is the winning bid. Independent private values information environment is the when each bidder present is aware with certainty about his/her own value of the auctioned item. However, awareness is based on the probability distribution of the other bidders values that are drawn independently. Nash equilibrium was first adopted by Vickrey (1961) for bid functions for a first price sealed bid auction and second price sealed bid auctions with independent private values for the item(s) being auctioned. The independent private values model is appropriate when the value of an object being auctioned is different for different bidders. For example, an antique piece to be purchased for private collection is an example of when this model is appropriate as such an item is different for bidders at the auction. In order to understand how both bidding strategies work, it is important to make a distinction between how first priced sealed bid auctions and second price sealed bid auctions differ. First Price Sealed-Bid Auction

A first price sealed bid auction is different from the English auction previously mentioned in the sense that the latter involve sequential bidding and everyone is entitled to participating in the bidding actions of others. This bidding auction starts off with each individual bidder writing his/her bid on a piece of paper secretly. The second step is when all bids are gathered at the same time by an auctioneer, who proceeds to call out the item to the person with the highest bid, who then purchases the item for the price written down. An example to further illustrate a first price sealed bid auction is that of storage warehouse business. Renters discard or evade on the rent for the storage spaces, which is why self-storage businesses tend to auction the contents of such storage spaces using first price sealed-bid auctions. This is done in order to try to in an attempt to regain a portion of their lost revenue from contents that were left behind. The most favourable strategy for the first price sealed-bid auction is quite complicated and more complex than that of a second price sealed bid auction. The theory of this strategy sets off from the assumption that every individual bidder determines his/her own valuation for the item privately, which is based on the independent private valuation model. Accordingly the values are distributed between a high and low price. Due to the privacy involved with bidders information and other bidders valuations, there is the issue of the winners curse that bidders try to avoid. In an attempt to doing that, individual bidders should reduce their bidding prices according to the following formula: b = v - (v - L)/n According to this formula, v is an individuals private valuation, L is the lowest probable valuation of the item, n is the number of bidders, and b is the resulting bid price.1 When the auction is competitive, the number of bidders is large, thus the downward alteration will be

James C. Cox, Vernon L. Smith, James M. Walker. (1998). theory and individual behavior of first-price auction. Journal of Risk and Uncertainty, 1, 61-99. Retrieved from http://excen.gsu.edu/jccox/research/firstprice.pdf

less and the outcome of the bid is closer to the determined value that is made privately by every bidder. Second Price Sealed-Bid Auction The second price sealed bid auction starts off in the same identical way as the first price sealed bid auction. The distinct difference between the two bidding strategies is that the person who wrote down the highest bid purchases the item but pays the amount of the second highest bid. This approach does not differ from an English auction, as in this case the winner is the person that calls the highest bid however, that bid does not necessarily mirror the highest value of the winner. Thus, in reality, the winner is paying his second-highest price. An optimal strategy for this type of bidding is to bid one's true valuation. The reasons for this are as follows. If an individual places a bid that is less than his/her valuation, then likelihood that the outcome of the bid will be successful is reduced. In addition, if an individual makes a bid that is more or higher than his/her valuation due to the fact that he/she will pay the second highest bid, the outcome of bidding more does not result in any greater payoff. However, by making higher bids in such a situation there is a risk that the next higher bid could be higher than one's own valuation. Positive economic profit therefore might not end up being recognized for the item being auctioned. When assessing both first and second price sealed bid auctions in independent private valuation, it is important to note that valuations for the items are private and determined independently of one another. In a second bid auction where every bidders bids his/her own value the sellers revenue is equal to the second highest value whereas first bid auctions involve bidders who submit the highest bid for the item and pays that price in order to purchase it. This bidding strategy is based on bidders that do not bid their true values otherwise no profit will be made. Thus, when bids are made below these values, potential

profit can be obtained. An example of second price auctions is that of Ebay as the search engine uses this pricing mechanism in order to sell and advertise. When it comes to bidding true value with independent private values, a second price sealed auction is the most beneficial strategy to use in determining the best bid choice in relation to the object being purchased. When it comes to first price sealed bid auctions however, finding the most favourable trade-o between the true value and ones bidding price is two factors that are complex, as the problem here depends on knowledge of the other bidders and how they have distributed possible values for the item being auctioned. An example of this is based on the intuition that naturally, ones bid should be higher and closer to his/her true value in first price auctions. In such an auction where there are a large number of competing bidders in comparison to one where there are less bidders, there tends to be a higher competing bid when there is a larger group of bidders present at an auction, which in turn results in the requirement of a bidder to make a higher bid (over that value) in order to be the highest. The winners curse is a phenomenon has been recognized and has a history in the study of auctions and bidding strategies. When bidders are to make bidding decisions, rationality should be taken into consideration when decisions are being made regarding bids. Bidders in auctions should make estimations based on the value of the item being auctioned based on private values and the object winning during the bidding process. Thus, during an optimal bid, the aim is to win the object rather than not win it. For example, in common-value auctions, bidders are more likely to reflect their bids downwards regardless of whether it is a second price sealed bid or a first price sealed bid. Furthermore, with first price sealed bid auctions, bid are reduced even further. In order to determine what an optimal bid is, a complex process is involved and in bidding auctions as such it is important to note that a winners curse can lead to losses for the winning bidder, especially when there is a large

number of bidders involved, an individual is more likely to win at the auction when overbiddings are made.

References: Auctions: Chapter 9. From the book Networks, Crowds, and Markets: Reasoning about a Highly Connected World. By David Easley and Jon Kleinberg. Cambridge University Press, 2010. Complete preprint on-line at http://www.cs.cornell.edu/home/kleinber/networks-book/
First Price Sealed-Bid Auctions. Retrieved from http://www.econport.org/econport/request? page=man_auctions_firstpricesealed.

Baye, Michael R. 2006. Managerial Economics and Business Strategy. McGraw-Hill/Irwin: New York, NY James C. Cox, Vernon L. Smith, James M. Walker. (1998). theory and individual behavior of first-price auction. Journal of Risk and Uncertainty, 1, 61-99. Retrieved from http://excen.gsu.edu/jccox/research/firstprice.pdf