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Introduction to Auctions
Auctions are another solution to an AI problem. The seller wants to charge the maximum willingness to pay, but does not know what this level is.
A form of price discrimination.
A well designed auction encourages the buyer (bidder) to reveal their willingness to pay. Auctions are most commonly used where there are a few items of high value to sell.
Auctions reading
Chapter 17 in Varian.
MKR have a sub-section in the AI chapter, but its not very detailed.
Klemperer, P. (2001) Why every economist should learn some auction theory.
http://www.nuff.ox.ac.uk/users/klemperer/WhyEveryEconomist.pdf
http://rru.worldbank.org/Documents/PapersLinks/auctions_and_bidding_a_primer.pdf
Dustmann and Borgers (2005) Strange Bids: Bidding Behaviour in the United Kingdoms Third Generation Spectrum Auction Economic Journal
http://www.ucl.ac.uk/~uctpb21/Cpapers/strangebids.pdf
Roth and Ockenfels (2002) Last-Minute Bidding and the Rules for Ending Second-Price Auctions: Evidence from eBay and Amazon Auctions on the Internet American Economic Review.
http://kuznets.fas.harvard.edu/~aroth/papers/eBay.veryshortaer.pdf
ECO2051 Intermediate Microeconomics
Auction design
Two factors to consider when evaluating auctions:
Profit maximisation
Is the seller achieving the maximum price?
Pareto efficiency
Is the good going to the bidder who values it the most?
Common values
There is a unique true value for the item (perhaps its resale value), but this value is unknown. Each bidder receives some noisy private signal about this true value. Signals are not common knowledge. E.g. buying an oil field. In a common value setting, if individual A learns that individual B values the good highly, then individual A will increase their valuation of the good. Half-way between the two previous cases. Valuations across individuals are non-independent, but not perfectly correlated.
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Affiliated values
Example
Imagine a painting is auctioned. Auction is the usual Sothebys type where individuals shout out their bids and the highest wins. There are four individuals with private valuations of 10, 40, 60 and 100. How much does the painting sell for?
Bidding strategy with independent values: English and second price auctions
Optimal to bid your valuation, .
Deviating from will not affect the price you end up paying (which is determined by the second highest valuation), but it will affect the probability of winning. To see this, suppose the highest bid by other bidders is .
You win whenever you make a bid above . Your surplus from this is positive providing that > . If you dont win, you obtain 0 surplus. Its optimal then to choose your bid so that you win the item whenever > . If you bid , then you will indeed win whenever > . Bidding a higher amount will mean you sometimes win and make a negative surplus, and bidding a lower amount will mean you sometimes lose when you could have won.
With either type of auction, bidders bid their valuation, and the price paid is the second-highest valuation.
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Bidding strategy with independent values: Dutch and first price auctions
Optimal to shade your bid, and bid below your valuation.
If you bid your valuation, although you will win often, when you do win you will gain zero surplus, since surplus is just your valuation minus your bid, under a first price auction. Thus you want to trade off the probability of winning, with the amount you obtain when you win.
Optimal strategy is to bid your expectation of what you would have paid had a second price auction been run instead, and had you won that auction.
Justification for this will be seen shortly. This is an increasing function of valuations, as you would expect. How much below the valuation it is will depend on how many bidders there are. With more bidders, bids will be nearer true valuations. This is why attracting bidders is an important element of auction design.
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You should have all received an email with a secret amount of money in it, last night. The amount in that email is the amount youll win if you win the auction. The auction will be an all pay one though, so everyone who participates will pay their bid.
If you want to participate, write down your name and your bid on a scrap of paper, fold it over, and pass it to the end of your row.
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will lead to the same expected revenue for the seller (and player of type can expect the same surplus across auction types).
The winning bid should be epsilon above the second highest valuation. (Source: Wikipedia)
The firm that performs the most units of research will win the patent race.
Useful fact
The expected th lowest draw out of from a uniform distribution on the interval , is + .
+1
The expected th highest draw out of from a uniform distribution +1 on the interval , is + .
+1
+1
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Conditional on the highest of the draws being , it may be shown that the other 1 draws are uniform on 0, . Thus the highest of these other 1 1 (i.e. the second highest overall) is expected to be at . Hence the firms expected surplus is
1
1 .
By the RET, this expected surplus must equal the expected surplus from the 1 1 ascending auction, hence = . I.e. =
1 1 .
1
For even moderately large , will be tiny for all but the very highest , so performing near zero amounts of research is optimal.
Risk aversion
Risk aversion removes the revenue equivalence of first and secondprice auctions. With risk aversion, people will bid higher in first price auctions compared to the risk neutral benchmark, since they prefer winning a small surplus with a high probability to winning a larger surplus with low probability.
First price auctions are thus likely to lead to higher revenue in the presence of risk aversion.
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Common values
Lets auction the contents of some of your wallets!
English auction. participants. Participant has in their wallet. Participant bids . They are allowed to bid more than , but all debts must be settled in full one way or another. Total in all of the wallets is =1 . The winner receives this amount, and pays the final bid with which they won. I.e. if participant wins, they get = =1 , from the auctioneer. (If this is negative they must pay the auctioneer.) Everyone else keeps their money.
If the winner just bid the contents of their own wallet, then they are guaranteed a positive value, so it certainly makes sense to set > .
If people stay in the auction until the price is equal to their expected valuation, they will over-bid, and suffer the winners curse.
Rational bidders shade their bids to avoid the curse.
Shading will be greater if there are more bidders; its worse to be the highest of many bidders. The English auction is no longer equivalent to the second-price sealed-bid auction, as the extra information modifies the impact of the winners curse.
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The auction was overseen by a team of academics acting as consultants: But perhaps the most important lesson of all was not to sell ourselves too cheap. Ideas that seem obvious to a trained economist are often quite new to layfolk. Our marginal product in preventing mistakes can therefore sometimes be surprisingly large.
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Bidders
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Winners
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Binmore and Klemperer: Of course, confidence in hi-tech industries in general has waned since that time. But the auction designs deserves neither praise nor blame if the values placed on the 3G licenses have now fallen because of a change in the capital markets view of 3Gs prospects.
There could be an element of winners curse here too.
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If the smaller licenses were identical you would expect firms to always bid for the cheaper license.
Example: Orange only bid for license E, this is only rational if Orange perceived E to be much more valuable than the other small licenses. Some evidence of irrational bidding, which goes against Klemperers idea that good design alone led to high prices.
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Theres an interesting paper, Maldoon, EJ 2005, who explains BT strategy in terms of common values. Switching was an attempt to confuse competitors. Or drive up the price paid by Vodaphone.
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Online auctions
You bid on an Ebay auction by inserting a maximum bid. The auction proceeds by using a proxy bidder who raises your bid as necessary by the minimum increment provided it doesnt exceed your maximum. This is very close to a second-price auction, the bidder with the highest valuation will win but at the second highest bid (plus minimum increment).
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Late bidding
The analysis of the second price auction implies that people will make straightforward bids and reveal their true valuation early on. In practice this does not happen. Late bidding or sniping is extremely common. Two explanations:
If there is an element of common value, no one wishes to reveal their valuation, as it could drive the final price up. Early bids make it likely that you will be bid right up to true valuation, late bidding adds an element of randomness which might be better for bidders on average.
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Advantages of auctions
Auctions are generally efficient. We want to allocate the good to the bidder who values it most.
As we have seen, auctions do this.
In beauty contests, its easy to say you value the good the most, but here you must put your money where your mouth is. (AI again) From the sellers point of view, they are the most effective way of gaining surplus. Transparent particularly important for Govt.
But auctions are expensive to run, so not suitable for all goods.
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