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Auctions and Their Performance in Economics

Tran Tri Duc

Columbia Southern University

MBAV 6053 Economics for Managers Unit IV Essay

Instructor Seifu Zerihun, PhD.

Date: March 26th, 2021

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Introduction

Auctions have a long history and can be considered as one of the most ancient model of

purchasing/selling commodity. Starting from ancient Greece where women were sold for

marriage to 5-star hotel halls where Van Gogh’s finest works are exhibited to bidders, auctions

have always played an important role in valuing goods. In this writing, we are about to have a

quick look at the way auctions are conducted and how they contribute to nowadays economics.

1. Types of auctions and their impacts

As you may have noticed, there are more than one type of auction. To be specific, there

have been at least several such as oral auction, second-price auction, reverse auction, etc.

An oral auction, also known as English auction or absolute auction, is the most antique

type within the above. In an oral auction, the bidder who call for the highest bid is the victor,

regardless of how much the goods is. In oral auctions, everything is public which means

participants know the bids of one another and they try to submit increasing bids until others

surrender so that they can be the last stand. The item being auctioned belongs to the highest

bidder offering the highest bid. However, the winner is not the one who determine the price of

the item. “Losing bidders determine the price” (Froeb, L. M. et al., 2018, p.240).

A second-price auction, which is from auction theory by William Vickrey, is a type of

sealed-bid auction (beside first-price auction). These auctions were thought to be rare at first but

turns out they are not that uncommon. In a second-price auction, the bids submitted by

participants are kept confidential. They do not know the price offered among them. Participants

are encouraged to bid their maximum value they are willing to pay acknowledging that if they

succeed, they just have to pay the second-highest bid value. Because it is also a seal-bid auction,
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participants have to submit their bids in writing. The auctioneers and sellers must guarantee these

bids are private and nobody should know one another’s proposal. The advantages of this type of

auction is that bidders cannot collude and it motivate bidders to “bid more aggressively because

their bid determines only whether they win, not the price they pay” (Froeb, L. M. et al., 2018,

p.236).

2. The relation between the number of bidders and winning bid in an oral auction

In an open and direct atmosphere like an oral auction, the temperature depends a lot on

the number of participants. More bidders certainly lead to more combative atmosphere. Let us

compare the outcomes of the two tables below to see how the winning bid is affected by the

quantity of participants.

In table 1, we have two bidders competing to own an item.

Bidder 1’s Offer ($) Bidder 2’s Offer ($) Probability (%) Winning Bid

20 20 25 20

20 30 25 20

30 20 25 20

30 30 25 30

(Table 1)

Now we examine the expected winning bid by using figures proposed by the high-value

bidder ($30) and low-value bidder ($20).

Expected winning bid equals 25%*20 + 25%*20 + 25%*20 + 25%*30 = $22.5

In table 2, now we have three bidders trying to own an item.

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Bidder 1’s Bidder 2’s Bidder 3’s

Probability (%) Winning Bid
Offer ($) Offer ($) Offer ($)

20 20 20 12.5 20

30 20 20 12.5 20

20 30 20 12.5 20

20 20 30 12.5 20

30 30 20 12.5 30

30 20 30 12.5 30

20 30 30 12.5 30

30 30 30 12.5 30

(Table 2)

Expected winning bid = 4*12.5%*20 + 4*12.5%*30 = $25

Figures from two tables point out that the more participants there are, the more expected

winning bid increases. Thus, to get higher winning bid in an oral auction, auctioneer and sellers

should gather as many bidders as possible.

3. The relation between the number of bidders and the outcome in a common value

auction

First of all, a common value auction occurs when bidders have distinct knowledge about

the object being auctioned. The most typical instance for it is an oil field which has not been

exploited yet. The amount of oil in the field remains a mystery while its value is the same for all

bidders. Bidders have to rely on their own sources of information, research, surveys to estimate

the volume of oil and then evaluate the entire field. Similarly to oral auctions, when the number

of participants rises, the atmosphere tends to be more and more competitive. The desire of
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becoming the winner pushes bidders to bid aggressively when there are more participants.

Because bidders are affected by the price that the others offer, they may adjust their price and

gradually make it go further than the price that is reasonable. This situation has a very unique

name in my opinion, is the winner’s curse. According to Pon Staff of Harvard Law School Daily

Blog, it happens when “the party who wins an auction of a commodity of uncertain value with a

fair number of bidders typically pays more than the asset is actually worth”. To avoid it, not very

difficult. Bidders have to be rational and bid less aggressively. Since bidders can be aware of the

strategy above, it is hard to conclude that the number of bidders can impact the outcome of a

common value auction.

Secondly, we investigate how it affects the price in four typical market structures when

there are changes in the number of producers.

- A perfect competition market contains a lot of buyers and producers who sell

indistinguishable products and also open to new firm to enter the market. Thus,

producers have little market power and that leads to the fact that auctions are almost

impossible to take place.

- A monopoly market only has one producer that dominates the entire market and

countless buyers so it has absolute market power. It is ideal for the seller to set any

price they want for their unique products. Auctions are a tool to help them get the

highest profits.

- An oligopoly market contains several large producers and they have reasonably high

market power. This type of market is divided into two types which are cooperative

oligopoly and non-cooperative oligopoly. In cooperative oligopoly market, collusion

happens in auctions and it help them to get more profits whereas firms have to
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compete with one another by applying strategic games in non-cooperative oligopoly

market to gain profits.

- A monopolistic competition also have many producers and buyers. Producers do not

have high market power since the products are various. Auctions are not easy to be

hold as there are plenty of substitutes. Bidders can offer a low price for their products

so producers do not gain much from auctions.

4. The required conditions for firms to price discriminate

Price discrimination involves charging a different price to different groups of people for

the same good (Pettinger, 2019). For instance, nowadays online sellers do not reveal their

products’ prices. Instead, they ask potential customers/viewers to leave them a message then they

will inform the price privately. The reason why sellers do that is because they need to check

buyers’ background based on what they post on social network and then offer differentiate

prices. To successfully price discriminate, firms must gather three factors. Firstly, they must

have market power. This means their products have to be unique or have little substitutes in the

market that leave buyers no other options but choosing theirs. Secondly, firms need the ability to

recognize differences in demand. This means if the demand for their products is inelastic, they

have the advantage to apply price discrimination. Last but not least, firms must foresee and

prevent arbitration as well as the resale of their products. We can see that luxury brands usually

eradicate their products when the season passes rather than sell them at a discount rate. This way

they can control the resale and keep price discrimination.

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References

Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2018). Managerial economics, A

problem solving approach (5th ed.). Cengage Learning.

Pon Staff of Harvard Law School. (2020). Winner’s Curse: Negotiation Mistakes to Avoid.

https://www.pon.harvard.edu/daily/business-negotiations/how-to-avoid-the-winners-curse/

Pettinger, T. (2019). Price Discrimination.

https://www.economicshelp.org/microessays/pd/price-discrimination/
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