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Auctions and Its Value in the Economy

Trần Thị Thuỳ Dung

Columbia Southern University

ACC 6053_Economics for Managers_Unit VI Essay

Dr. Seifu Zerihun

Due date: March 14th, 2021

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Introduction

Commodity auction is one of the most common selling/buying forms in economy. This is

a method of determining the value of a good whose price cannot be determined or changed too

much. Through auction, buyers and sellers can buy and sell the goods at a price roughly equal to

its value. The history of human economic development has recorded auctions from ancient times

all over the world with many different forms and laws. In addition, the goods for auction are also

amazingly diverse, from beautiful women to pitiful slavery destinies. Fortunately, with the

constant development of awareness, today the auction form still exists, but the goods to be

auctioned are no longer human, but only material as a work of art, a a particular item, a project, a

commercial service ...

This essay is written to partly clarify the value that auctions bring to the economy today.

Through the specific sections mentioned below.

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Part 1: Difference between Oral Auction and Second-price Auction:

Firstly, let's find out through the various forms of auction. Auction does not only have

one form of conduct but there are many different forms, such as: oral auction (English auction),

second-price auction (Vickrey auction), sealed-bid first-price auction, common-value auction.

Regarding oral auction and second-price auction, there are differences between these two types.

Oral auction: the name of this type of auction totally tells us the way it conducted.

Buyers/bidders do not need to prepare bidding documentation since they can use direct voice to

offer the price they want for the good. This is a form of public auction, where all the buyers

know immediately the price offered by the competitors.

An oral auction normally to be conducted in the following order:

 Introducing seller, the seller’s assistant; publish a list of buyers/participants and the roll

call to identify auction participants;

 Read the rules of the auction;

 Introduction of each auctioned asset;

 Reiterating the starting price in case the starting price is made public;

 Announcing the price step and the maximum time interval between two bids;

 Distribute numbers to auction participants;

 Instructions on how to bid, accept prices and answer questions of auction participants;

 Administer the bidding and price acceptance according to regulations.

Of course, each country has different rules about how the steps are taken, but in general,

the main steps above are necessary. The results of the oral auction are available right through the

auction, at the end of the session, when the final price is offered while there is no other buyers
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offer another more competitive price (higher or lower depending on whether auctions type are

price increasing or price decreasing) after the specified waiting duration. Oral auction is an

auction where an participant himself will in turn make a price directly orally, therefore, no one

else could know the price information, as it is flexibly changed depending on the actual situation

happening at the auction.

In oral or English auctions, the highest bidder wins but only has to outbid slightly above

the second-highest bidder. Losing bidders determine the price, according to Managerial

Economics (5th ed., p.240). This means the winner although offer the price that he can afford it

however he/she just have to pay a lower price which is offered by the second-highest bidder.

Second-price auction (or Vickrey auction) is a type of sealed-bid auction in which

bidders submit their bidding document without knowing the bidding price of other participants.

Unlike Oral auction, second-price auction and first-price auction are types of sealed-bid auction.

In a first-price auction, bidder who wins will pay the price that proposed by himself/herself

proposed while winner in a second-price auction just have to pay the second-highest price.

Beside, as a type of sealed-bid auction, bidders of a second-price auction need to prepare their

bidding documents in advance to submit to the seller. Inside the bidding document, the price is

proposed and cannot be changed after submission. This price is kept secret among bidders.

Auctioneer knows the proposed price of each bidders, however, there is no information shared

among bidders. In fact, this kind of bidding contains many shortcomings in the confidentiality of

bidding-price information. Since it is a sealed-bid auction, all documents are prepared in

advance, therefore, bidding-price information may be leaked out in some way.

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Part 2: The quantity of bidders affects the result in an oral auction

In the form of an oral auction, the participant will bid directly at the auction, of course the

degree of competition depends on the quantity of participants. The more bidders, the fiercer

competition and vice versa. Therefore, when there are more bidders, the price will be offered

more times. And of course, the more times it is offered, the higher the price will be. Some

auctions have a step-by-step price setting, the more predictable the price is. The table below

illustrates this more clearly, assuming that this good has two bidders.

Bidder 1’s price ($) Bidder 2’s price ($) Probability (%) Winning price ($)

100 100 25 100

120 100 25 100

100 120 25 100

120 120 25 120

As illustrated in the table above, there are two bidders of which the high-value bidder’s

price is $120, the low one is $100. We see that the probability of the item being bought for low

price is 25% + 25% + 25% = 75%, while the probability of an item being bought at a high price

is only 25%. So, the expected revenue is the weighted average of those two outcomes: 100 $ x

75% + $120 x 25% = $105

In the other hand, let examine how the result changed of there are three bidders instead.

Assuming that these three bidders still have two prices: low-value price $100 and high-value

price $120. Now the probability that the item being bought for low-value price has decreased

from 75% in the previous case to 50% in this case. Along with that, the probability that the item

being bought for high-value price has increased from 25% in the previous case to 50% in this
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case. This means the weighted average of the two price has changed as well. We can calculate

the expected revenue like this:

$100 x 50% + $120 x 50% = $110 (greater than $105 of the two bidders case above).

Therefore, the more bidders participate, the higher the winning price is.

Bidder 1’s price Bidder 2’s price Bidder 3’s price Probability Winning price

100 100 100 12.5% 100

100 100 120 12.5% 100

100 120 100 12.5% 100

120 100 100 12.5% 100

100 120 120 12.5% 120

120 100 120 12.5% 120

120 120 100 12.5% 120

120 120 120 12.5% 120

Part 3: The quantity of bidders affects the outcome in a common value auction

3.1. Common value auction is a kind of auction where each bidder has their own

information about the value of the item they are going to bid. For example an oil track, a rough

gem…

Obviously the true value of the item is there and unchanged among the bidders, however,

nobody knows exactly about it as it is not measured before. Accordingly, each bidder will base

on their own information source, their knowledge as well as their experience about the item to

bid.
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In a common-value auction, if the number of bidders increases, the competition are

generally become more fierce. The bidder who wants to maintain the chances of winning will

more aggressive. However, as the value of the item hasn’t precisely estimated, the rational

bidders tend to avoid the winner’s curse, and the result is they will less aggressive. To avoid the

winners’ curse, you bid less aggressively as the number of bidders increases, (Textbook, p.239)

It means the increase of bidders can bring two counteracting effects on bidding behavior. We

cannot conclude anything about the effect of number of bidders on the outcome in an common-

value auction.

3.2. Based on the number of producers, let see how it effect the price in different market

structures. As we know, different market structure consists of four categories:

3.2.1. Perfect competition: there are many buyers and sellers in the market. The sellers

sell identical products. In this case, sellers cannot affects the price of product. This leads to the

impossible of auction.

3.2.2. Monopolistic competition: there are many firms and many buyers as well.

However, the diversity of products are quite high. Therefore, auction can do nothing to get high

benefit as the sellers has low market power.

3.2.3. Oligopoly: there is a few of large firms who sell identical or different product.

Auction can be appled in this kind of market and the price of product are affected by these firms.

As for collusive oligopoly (cartel), the firms have a collusion to get higher profit/benefits from

the auctions. As for the non-collusive oligopoly, benefits from auction are not higher yet lower

than the collusive price, the firm will accept the competition.

3.2.4. Monopoly: there is only one seller in this market while there are a lot of buyers.

The seller sell unique products. This is an ideal circumstance for the seller to get whatever price
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they want because they got the highest market power. Auction will help them to get highest

benefits.

Part 4: Price discrimination’s necessary conditions

Price descrimination is a selling strategy that charges customers different prices for the

same product or service based on what the seller thinks they can get the customer to agree to.,

according to Twin A. (Jul, 2020).

At the Equilibrium point, there is no price descrimination. The first-degree price

descrimination is the case that buyers willing to pay the firm’s product at a specific price (Ex: the

price after negotiation; bargaining price...). The firm get additional profit if the apply first-degree

descrimination, compare with the profit at equilibrium. This case is possible when the products

have inelastic demand.

Second-degree price descrimination is the case that the form offer the high price for the

small amount of product bought, and give discount for the large amount of product bought.

The third-degree price descrimination is the case that the firm devides buyers into

different groups to charge at different price.

So, the first condition for a firm to be able to price descriminate are the type of market structure.

The firm must have market power. This means the market is the monopoly and monopolistic

market. Secondly, the product has to be unique or differentiated. Thirdly, price demand elasticity

affect the firm’s ability to price descriminate. If the product has inelastic demand, buyers willing

to pay at any price for the product.

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References

Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2018). Managerial Economics (5th ed.)

Twin A., (Jul, 2020). Price Descrimination

https://www.investopedia.com/terms/p/price_discrimination.asp