AUCTION AS A GAME

NOW WE NEED TO SEE AUCTION AS A GAME

IT WOULD BE GOOD IF WE CAN MODEL AUCTION AS A NORMAL FORM GAME

IN A NORMAL FORM GAME WE NEED THREE CLEAR ELEMENTS :

1.LIST OF PLAYERS

2.SET OF STRATEGIES

3.UTILITY OR PAYOFF ASSOCIATED WITH THE DIFFERENT STRATEGIES.

WITH THESE ELEMENTS WE GET HOLD OF A SIMPLE AUCTION MODEL.

HERE THE POTENTIAL BIDDERS ARE THE PLAYERS. IN AN AUCTION THERE CAN BE ANY NOS. OF BIDDERS.
LET US ASSUME HERE THAT THE AUCTION IS ONE-SIDED AND ONLY THE BUYERS BID. THEREFORE IN
MODELLING THE GAME WE CONSIDER N NOS. OF POTENTIAL BUYERS TO BE THE PLAYERS.

What WILL BE THE SET OF STRATEGIES? IT DEPENDS ON HOW MUCH MONEY ANY BIDDER/BUYER BIDS.
IT WILL BE FROM ZERO TO ANY NUMBER HE CAN MANAGE. SO THE PLAYERS THEORETICALLY CAN BID
FROM ZERO TO INFINITY . SO SET OF STRATEGIES COME FROM A SET OF NON-NEGATIVE NUMBERS.
( BIDS ARE NEVER NEGATIVE. EVEN IN CASE OF DESCENDING PRICE AUCTION/DUTCH AUCTION THERE
WILL BE A FLOOR PRICE BELOW WHICH THE BID CANNOT FALL)

THE PAYOFF CAN BE DETERMINED ON THE BASIS OF A NUMBER OF FACTORS. BASICALLY DEPENDS ON
THE STRATEGY PROFILE. IF HE WINS THEN THE GAINS WILL BE EQUAL TO HIS VALUATION MINUS WHAT
HE PAYS. THIS WILL DEPEND ON THE AUCTION TYPE. ON THE OTHER HAND, IF HE LOSES THAT IS IF HE
DOESN'T WIN THEN HE PAYS NOTHING NOR DOES HE GAIN ANYTHING. SO IT IS ZERO GAINS.

THE EXACT PAYOFF IS NOT OBTAINED AS YET. IT WILL DEPEND ON THE TYPE OF THE AUCTION, TYPE OF
THE VALUATION DONE BY THE BIDDERS/PLAYERS AND HOW THE WINNER GETS DECIDED.

THE RULE OF THE AUCTION WOULD DECIDE THE PAYOFF AND HENCE THE GAME.

AT THE SAME TIME THE VALUATIONS AND THE BIDS OF THE OTHER PLAYERS TOO WOULD HAVE A ROLE
TO PLAY ON THE PAYOFF.

IT IS TO BE NOTED THAT THE SELLER ALTHOUGH DECIDES THE FORMAT OF THE AUCTION HE REMAINS
PASSIVE ,THAT IS HE DOESN'T ACTIVELY PLAY DURING THE PRICING PROCESS.

MODELLING OF VICREY AUCTION AS A GAME:

LET US NOW CONSIDER VICREY AUCTION WHICH IS THE SECOND PRICE AUCTION UNDER SEALED BID
ONE-SIDED AUCTION.
SO THE PAYOFF OF ANY POTENTIAL BUYERS/BIDDER WILL BE THE AMOUNT WHICH IS THE DIFFERENCE
BETWEEN THE VALUATION ASSOCIATED WITH THE GOAL/OBJECT AND AMOUNT OF THE SECOND
HIGHEST BID THAT HE PAYS.

LET US ALSO ASSUME THAT THE BIDDERS/PLAYERS WORKING ON PRIVATE VALUATION.

NOW WE NEED TO FIGURE OUT IF IT WOULD BE POSSIBLE TO GET NASH EQUILIBRIUM OF THIS GAME.

THE TECHNIQUE WE ARE USED TO IN A NORMAL FORM GAME IS THE DRAWING OF TABLES. THIS
WOULD BE A LITTLE DIFFICULT HERE BECAUSE OF ' N' POTENTIAL BUYERS AND ENDLESS NUMBER OF
STRATEGIES/BIDS. INFINITE BIDS FROM FINITELY HUGE BUYERS. EVEN BETWEEN 0--1 THERE WOULD BE
INFINITE REAL NUMBERS , THE NUMBERS THAT THE PLAYERS CAN BID.

SO ONE WAY OF WORKING THIS OUT IS RESTRICT OURSELVES TO ONLY THE WHOLE NUMBERS AND
MAKE A SMALLER TABLE THAT WOULD WORK. YET IT IS ALWAYS PRUDENT AND FAIR TO ALLOW
PLAYERS TO BID ANY NON-NEGATIVE NUMBERS.

TO FIGURE OUT NASH EQUILIBRIUM WE NEED TO SEE WHETHER THERE EXISTS ANY DOMINANT
STRATEGY HERE. IT IS ALSO TO SEE WHETHER THERE IS STRICLY DOMINANT STRATEGY OR WEAKLY
DOMINANT STRATEGY. IF SUCH A STRATEGY EXISTS THEN WE CAN CONSIDER TO HAVE A DOMINANT
STRATEGY EQUILIBRIUMEQUILIBRIUM THAT IS A NASH EQUILIBRIUM.

OPTIMAL BIDDING STRATEGY UNDER VICREY AUCTION :

(NOTE : AT THIS LEVEL WE ARE GOING TO WORK ON VICREY AUCTION OR SECOND PRICE SEALED BID
AUCTION ONLY)

A BIDDER'S STRATEGY CAN BE CLASSIFIED IN THREE DIFFERENT CATEGORIES.

1.FIRST STRATEGY IS TO BID TRUTHFULLY. THIS MEANS THE BIDDER'S BID(B) EQUALS HIS VALUATION (V)
OF HIS OBJECT/PRODUCT.THAT IS B=V.THIS IS KNOWN AS TRUE BIDDING. MORE GENERALLY IT IS
EXPRESSED AS,

Bi=Vi, i BEING THE 'i' TH BIDDER.

SO FOR ANY PLAYER 1,V1 =₹10000 THEN HIS BID B1=₹10000.

2.SECOND STRATEGY IS TO BID HIGHER THAN HIS TRUE VALUATION OF THE PRODUCT. THAT IS, B>V. SO
HIS BID WILL BE MORE THAN ₹10000.NOT ONLY THAT. THE BID CAN BE A SET OF ANY NON NEGATIVE
NUMBER GREATER THAN 10000(HOWEVER, HIS FIRST STRATEGY BEING B=V, HAS ONLY A SINGLE
ELEMENT.)

3.THIRD STRATEGY IS TO BID LOWER THAN HIS ACTUAL VALUATION OF THE PRODUCT. THAT IS, B<V.
HERE ALSO THE BIDS OF THE PLAYER CAN BE FROM A SET OF ALL NON NEGATIVE NUMBERS LESS THAN
10000.
NOW WHAT HAPPENS WHEN THE BIDDER/PLAYER 1 BIDS TRUTHFULLY?

TWO SITUATIONS ARISE.

1.BIDS HONESTLY: WINS THE AUCTION

2.BIDS HONESTLY: LOSES THE AUCTION.

BIDDING HONESTLY ITSELF DOESN'T RESULT IN A WIN. PLAYER 1 WINS IF HIS BID IS THE HIGHEST. IF
NOT, THEN HE LOSES, THAT IS , HE DOESN'T WIN THE AUCTION.

ONE POINT TO REMEMBER IS THAT IF THE PLAYER IS PLAYING HONESTLY AND HAS THE HIGHEST BID,
THEN, HIS VALUATION TOO IS THE HIGHEST. (THE UNDERLYING ASSUMPTION IS ALL ARE PLAYING THE
SAME STRATEGY.)

UNDER VICREY AUCTION, THE WINNER PAYS THE SECOND HIGHEST BID IF HE WINS. SO HIS PAYOFF
WOULD BE V1- B2, THAT IS, HIS VALUATION MINUS THE SECOND HIGHEST BID. IF HE LOSES OR DOESN'T
WIN THEN HE PAYS NOTHING OR WINS NOTHING. THEREFORE HIS PAYOFF WILL BE ZERO.

NOW PLAYING STRATEGY 1, THAT IS, PLAYING HONESTLY MAY RESULT IN A WIN IF HIS BID=VALUATION
IS HIGHEST. IN THAT CASE, HIS PAYOFF WOULD BE +VE PROFIT. IF HIS BID=VALUATION IS NOT THE
HIGHEST THEN HE LOSES THE AUCTION AND HIS PAYOFF HERE WOULD BE ZERO.

THUS STRATEGY OF PLAYING TRUE TO HIS VALUATION MAY ENABLE THE PLAYER TO GAIN. THIS CAN BE
MADE CLEAR FROM BELOW

SITUATION 1 SITUATION 2

B1=V1 B2

B2 B1=V1

B3 B3

B4 B4

IN THE FIRST CASE PLAYER 1 WINS PLAYING HONESTLY. BID AND VALUATION ARE THE SAME. THE BID IS
THE HIGHEST. HE PAYS B2. PAYOFF IS V1-B2=+VE PROFIT

IN THE SECOND SITUATION PLAYING HONESTLY IS NOT ALLOWING THE PLAYER 1 TO WIN AS THE PLAYER
2 HAS THE HIGHEST BID B2>B1. HERE THEREFORE THE PLAYER1 DOESN'T WIN THE AUCTION, NEEDS TO
PAY NOTHING NOR GAINS ANYTHING. SO HIS PAYOFF WOULD BE ZERO.

PLAYING HONEST THUS GIVES A CHANCE TO GAIN.

NOW LET US LOOK AT THE SECOND STRATEGY.

HERE THE PLAYER 1 IS BIDDING HIGHER THAN HIS VALUATION. B1>V1.THERE COULD BE THREE
SITUATIONS AS SHOWN BELOW.

SITUATION1 SITUATION 2 SITUATION 3

B2 B1 B1

B1 V1 B2

B3 B2 V1

V1 B3 B3

B4 B4 B4

THE FIRST SITUATION UNDER STRATEGY 2 HAS THE SECOND PLAYER BIDDING THE HIGHEST. SO HE
WINS AND NOT THE PLAYER 1 . PLAYER 1 IS BIDDING ABOVE HIS VALUATION. PAYOFF IS ZERO. IF
INSTEAD HE HAD PLAYED HONESTLY EVEN THEN HIS PAYOFF WOULD HAVE BEEN ZERO.

SO PLAYING HONESTLY OR PLAYING HIGHER THAN THE VALUATION THE SITUATION IS A NO WIN
SITUATION FOR PLAYER 1AND HIS PAYOFF REMAINS AT ZERO.

THE SECOND SITUATION HAS PLAYER 1 AS THE HIGHEST BIDDER BIDDING HIGHER THAN HIS VALUATION
V1. HE WINS. PAYS EQUAL TO THE SECOND HIGHEST BID B2. PAYOFF WOULD BE V1 -B2=+VE PROFIT. IF
HAD HE PLAYED HONESTLY AND BID EQUAL TO V1 THEN ALSO HE WOULD HAVE WON AS B1>B2.PAYOFF
WOULD HAVE BEEN V1 -B2 =+ VE PROFIT.

SO PLAYING HIGHER THAN HIS VALUATION OR PLAYING TRUTHFULLY HE WINS WITH THE SAME PAYOFF.

THUS, IN CASE OF STRATEGY 1 AND STRATEGY 2 , PLAYING TRUTHFULLY OR HONESTLY ALWAYS AS

GOOD AS BIDDING HIGHER/MORE THAN HIS VALUATION.

THE THIRD SITUATION TOO MAKES PLAYER 1WIN BIDDING HIGHER THAN HIS VALUATION. HE PAYS THE
SECOND HIGHEST BID B2. CLEARLY HE HAS TO PAY HIGHER THAN HIS VALUATION, THAT IS, B2>V1. HIS
PAYOFF NOW WOULD BE V1-B2=-VE PROFIT. IF INSTEAD HE HAD PLAYED HONESTLY PLAYER 1
WOULDN'T HAVE WON AS B2>B1=V1.HIS PAYOFF THEN WOULD HAVE BEEN ZERO.

WE ALL KNOW ZERO IS BETTER THAN A NEGATIVE VALUE. IN OTHER WORDS IF HE HAD PLAYED
HONESTLY HE WOULD HAVE BEEN BETTER OFF.

WHAT WE GET TO SEE FROM THE THREE POSSIBLE SITUATIONS UNDER STRATEGY 2 ?

IN SITUATIONS 1 AND 2 PLAYING HONESTLY OR NOT THE SITUATIONS REMAIN THE SAME. THAT IS
BIDDING TRUTHFULLY IS AS GOOD AS BIDDING HIGHER. IN THE THIRD SITUATION HOWEVER SHOWS
THAT IT IS BETTER TO PLAY/BID HONESTLY.
NOW LET US LOOK AT THE THIRD STRATEGY. HERE THE BIDDER BIDS LOWER THAN HIS VALUATION.
THAT IS B1< V1. THIS CAN DEVELOP THREE POSSIBLE SITUATIONS AS SHOWN BELOW.

SITUATION 1 SITUATION 2 SITUATION 3

B2 V1 V1

V1 B1 B2

B3 B2 B1

B1 B3 B3

B4 B4 B4

CONSIDER THE FIRST SITUATION. HERE PLAYER BIDS LESS THAN HIS VALUATION AND IT IS NOT THE
HIGHEST BID HERE. SO, HE DOESN'T WIN. PAYOFF IS ZERO.

DOES THE SITUATION CHANGE IF HE PLAYS HONEST? IT DOESN'T. IN OTHER WORDS PLAYING HONESTLY
OR NOT THE PAYOFF REMAINS THE SAME.

IN CASE OF THE SECOND SITUATION PLAYER 1 BIDS THE HIGHEST ALTHOUGH HE BIDS BELOW HIS
VALUATION. HE WINS. PAYS EQUAL TO THE SECOND HIGHEST BID B2 AND HIS PAYOFF WOULD BE V1 -
B2 = +VE PROFIT.

NOW, DOES HIS SITUATION CHANGE IF HE BIDS HONESTLY AT V1. IT DOESN'T. HE STILL WINS, PAYS THE
SAME B2 AND GETS THE SAME PAYOFF AS BEFORE.

LET US NOW LOOK INTO THE THIRD SITUATION. BIDDING BELOW HIS VALUATION DOESN'T ALLOW HIM
TO WIN. PAYOFF IS ZERO. HOWEVER IF HE CHANGES STRATEGY TO STRATEGY 1 AND PLAY HONEST HE
COULD HAVE WON WITH A POSITIVE PAYOFF.

ANALYZING ALL THE THREE STRATEGIES WE FIND THAT BIDDING HONESTLY IS ALWAYS AT LEAST AS
GOOD AS BIDDING EITHER MORE OR LESS THAN THE PLAYER'S VALUATION. IN SOME CASES BIDDING
HONESTLY IS STRICTLY BETTER THAN BIDDING HIGHER OR LOWER THAN HIS VALUATION. IN OTHER
WORDS, BIDDING HONESTLY DOESN'T REDUCE THE CHANCES FOR THE BIDDER. OUT OF ALL THE THREE
STRATEGIES BIDDING HONESTLY THAT IS THE STRATEGY 1 WEAKLY DOMINATES THE THREE. HENCE WE
GET A NASH EQUILIBRIUM UNDER VICREY AUCTION.

WHAT WE NEED TO KNOW IS THE FACT THAT ALTHOUGH WE ARE TALKING ABOUT PLAYER 1 AND HIS
STRATEGIES, WE ARE ACTUALLY DEALING WITH ANY PLAYER i, WITH VALUATION Vi AND BIDS Bi. SO ALL
THE PLAYERS WOULD FOLLOW STRATEGY 1 AND ATTAIN NASH EQUILIBRIUM.

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