the

evolution
of
auction
theory
BY HAFSA JAHAN
the evolution of auction theory
by hafsa jahan
Buyers and sellers simultaneously submit
competing bids and offers in an auction
market. In essence, auction theory is
concerned with how auctions result in the
determination of a commodity's price.
Auction theory looks at how they are set up,
what rules they follow, how bids act, and
what results they produce. The most
competitive bidder would purchase the
commodities from the ancient traders'
shipment.
A market where buyers and sellers
concurrently place competing bids is known
as an auction market. Public purchases may
also be made through auctions. Auctions
have long been a popular method for selling
a variety of commodities, including artwork
and government securities. Because buyers
and sellers think they will receive a good
deal buying or selling assets, auctions are
popular. In essence, an auction is a sales
event where prospective customers submit
aggressive offers for goods or services in
either an open or closed format. In an open
auction, the highest bidder receives the
asset or service in question, while in a
closed auction, the highest bidder typically
does.
Bidders are unaware of competing bids at a
closed auction, such as the sale of a
company. In recent years, there have been
an increasing number of auction data
available for empirical research. This, along
with the available theory, has generated an
expanding amount of empirical research on
auctions. Bidders are aware of each other's
bids in an open auction, such as a livestock
auction. The orders are then carried out
after matching bids and offers have been
coupled. It is easier for sellers to identify
the bidders who value the goods the highest
when prospective purchasers fight to
purchase them in an auction. Additionally,
selling products to the highest bidder
increases the seller's profits.
So auctions are advantageous for both
buyers and sellers.
What is auction theory?
Auction theory is an applied branch of
economics which studies how auctions are
designed, the rules that control them, how
bidders behave in auction markets and how
the characteristics of these marketplaces
encourage predictable results.
The most significant contemporary use of
auction theory has been greatly influenced
by Paul Milgrom. Paul R. Milgrom and
Robert B. Wilson received the 2020 Nobel
Prize in Economics "for improvements to
auction theory and innovations of new
auction formats."
What are auctions?
Auctions are an event where
different parties can bid for the
right to purchase a good or service.
More and more commodities and
services have been put up for
auction over time, particularly in
the last three decades. Different
parties might place bids at auctions
in order to win the opportunity to
buy a good or service. The selling
and acquisition of items may be
more effectively handled through
auctions.
They mostly serve a range of purposes.
When it comes to expensive and rare
goods, the situation can be very
different. It's because it can be quite
challenging to price these expensive
items. As a result, the market would have
significant issues if these products are
not priced adequately. That's why,
auctions are mostly used to price these
high-priced goods. It is all about how
auctions lead to the discovery of the
price of a commodity.
Making the most revenue as possible is one of
the key goals of the sellers. They will be able to
invest their retained earnings in this way,
eventually growing their company. While
allowing buyers to purchase at a lesser cost,
sellers employ the auction idea to increase
revenues. Firstly, we have to note about what
economic equilibrium is all about. Economic
equilibrium in economics refers to a scenario
where supply and demand are balanced and
the values of economic variables do not change
in the absence of external factors. Therefore,
the price agreement between the buyer and
seller serves as an indicator of economic
equilibrium.
When people pursue their rational self-
interest, a less-than-ideal or economically
inefficient result results from the market.
Sellers typically set very high prices for the
goods and services they produce in a
monopolistic market. The cost of the
products becomes an issue for the
consumers as a result. Sadly, people are
left with little choice but to buy those
exorbitantly expensive goods. Auction
theorists develop auction rules to solve
issues that can lead to market failure.
TYPES OF AUCTION
1) First-price sealed-bid auction:
The most typical kind of auction is a first-price
sealed-bid auction (FPSBA). The FPSBA is also
referred to as a blind auction. All bidders
simultaneously make sealed bids in this kind of
auction, ensuring that no one is aware of the bid
of another participant. In other words, neither the
top nor the lowest bidder will be able to predict
what the other bidders would offer throughout
the auction. It is entirely kept anonymous in this
manner. The lowest bidder's offer is rejected from
the auction in the end, and the highest bidder
pays the sum that was promised. In a FPSBA, each
bidder is characterized by their monetary
valuation of the item for sale.
In a first-price sealed-bid auction, a bidder
always proposes less money than they
would have thought the item was worth.
The primary motivation is to profit
significantly from the auction. It goes
without saying that the buyer will lose
money if they outbid the object's value and
win the auction. Her anticipated profit will
therefore either be zero or negative. Since
bids are placed below the bidders' values,
the first-price sealed bid auction is not a
tool for disclosing demand.
Bidders are trading between placing high
bids to increase their chances of success and
placing low bids to increase their chances of
success. However, we also have to note that
only one bid is submitted per bidder. In
order to maintain and comply with all the
rules of the auction, here is no sequential
contact or kind of communication among
bidders in a first-price sealed-bid auction.
Suppose Jaiden is a bidder and he has
decided to set his valuation to 1000 dollars.
Before moving onto the next point, let's
know what rational behavior is all about.
A decision-making process centered on
choosing decisions that produce the highest
possible amount of value or utility for an
individual is referred to as rational behavior.
According to the presumption of rational behavior,
people choose to pursue acts that are in their best
interests rather than those that are neutral or harmful
to them.
Now, three scenarios are likely to occur if Jaiden is
rational:
1) He won't lose money if he bids exactly $1,000, but he
also won't get anything of worth.
2) He will never bid more than $1,000 because doing so
will result in a decrease in his net value.
3) If he places a bid for less than $1,000, he might make
a profit, but the amount will depend on what the other
bidders place.
Jaiden would obviously have to place the lowest
possible offer, as long as it is less than $1,000, in hopes
of winning the item.
WHAT WOULD JAIDEN DO IF THERE’S AN
ADDITONAL BIDER?
Let’s say, along with Jaiden, there’s another bidder
named Roger. Roger has decided to bid $700. Jaiden
was supposed to bid $1000 which means that he
possesses a greater amount of money than Roger. The
difference between their amount is $1000-$700=$300.
In this case, since $700 is less than $1000, Jaiden may
most likely bid $700 + x. The value of x is the smallest
amount that should be added in order to exceed
Roger’s bidding value. There is no specific amount,
however, it can be as small as only one cent. In this
way, Jaiden has greater possibility of winning in the
auction.
But regrettably, Jaiden is unaware of Roger's proposed
bid. Additionally, he has no idea about the amount that
the other bidders who participated in the auction was
going to bid. This definitely creates a lot of uncertainty
for Jaiden, Roger and the rest of the bidders. They
would not be able to predict or guess the value of what
other parties are willing to bid and as a result, they
may not be able to make a gain/profit in the auction
that took place. From a strategic standpoint, we have a
Bayesian game, in which agents are unaware of each
other's payoffs.
WHAT ARE BAYESIAN GAMES?
Bayesian games are also known as games with
incomplete Information. These are models of
interactive decision-making scenarios where the
decision-makers, also known as players, have only
partial knowledge of the game's facts and the
information about the other players. A Bayesian game
in game theory is a game that incorporates elements of
Bayesian probability to simulate the result of player
interactions. In three publications published in 1967
and 1968, Hungarian economist John C. Harsanyi
established the idea of Bayesian games. For these and
other contributions to game theory, he received the
Nobel Prize in 1994.
RELATIONSHIP BETWEEN JAIDEN AND ROGER’S
CASE AND BAYESIAN GAME:

Jaiden, regrettably, has no idea what the other bidders

will offer. As a result of not knowing how much Roger
will offer in the auction that is now taking place, this
eventually leads to uncertainty. Furthermore, he is not
even aware of what the other bidders are willing to
pay. We learned what Bayesian games are in the
paragraph before. As a result, from a strategic
standpoint, Jaiden and Roger are involved in a
Bayesian game, which is a game in which the agents
are unaware of the outcomes of the other players.
WHAT IS A BAYESIAN NASH EQUILIBRIUM?
A Bayesian Nash equilibrium (BNE) is a strategy profile
that optimizes each player's expected return in light of
their beliefs and the strategies employed by the other
players.
The reason why we need to know what a Bayesian
Nash equilibrium is because we need to acknowledge
the fact that even though there are only two bidders:
Jaiden and Roger, it can be extremely difficult to find
the Bayesian Nash Equilibrium in their case.
2) SEALED-BID SECOND-PRICE AUCTION (SBSPA)
A Vickrey auction is also known as a sealed-bid
second-price auction, or SBSPA. Although stamp
collectors had been using the auction since 1893, it
wasn't until 1961 that Professor William Vickrey of
Columbia University gave it a formal academic
description. A sealed-bid auction is one such as the
Vickrey auction. Without knowing the other bids at the
auction, bidders make their offers. As a result, it is
kept private, and bidders may have a hard time
forecasting the precise amount of bid that other people
will be ready to make. The highest bidder in a Vickrey
auction wins, but the price paid is the second-highest
bid. It is a dominant strategy in a second-price auction
for a bidder to bid their true value. The sealed-bid
second-price auction (SBSPA) is also known as the
"demand revealing mechanism" at times.
EXAMPLE OF SEALED-BID SECOND-PRICE
AUCTION (SBSPA)
Let's say, there is a bidder named Nicki who decided to
bid in the auction that was going to take place this year
for an artwork. Nicki's valuation for the artwork is
$4000.
Let's say the highest competing bid is $3000. It is
obvious that Nicki's $4000 bid was higher than $3000.
Nicki would, of course, end up taking home the art
piece. Additionally, if Nicki bids her own worth of
$4000, she will also be able to make
$4000-$3000=$1000. No further bids may increase
Nicki's earnings. The best Nicki could do if her bidding
value was less than $3,000 is to place a bid below
$3,000 and receive nothing. Nicki places a $4000 offer
and receives exactly zero dollars. Overall, Nicki should
bid $4000 because that is the greatest option.
3) Open ascending-bid auctions (English auctions)
English auctions are another name for open
ascending-bid auctions. An open-outcry ascending
dynamic auction is taking place. The auctioneer
gradually increases the price until only one bidder is
left, and that bidder purchases the item for the total
amount that was offered.
Let's say Joseph, the auctioneer, launches the sale by
stating a suggested opening bid, a beginning price, or a
reserve for a valuable antique up for bid. The
auctioneer then takes progressively higher bids from
the audience. There are already several bidders in
attendance who have participated in the auction.
There are other bids as well, though, who will also be
taken into account.
3) Open ascending-bid auctions (English auctions)
English auctions are another name for open
ascending-bid auctions. An open-outcry ascending
dynamic auction is taking place. The auctioneer
gradually increases the price until only one bidder is
left, and that bidder purchases the item for the total
amount that was offered.
Let's say Joseph, the auctioneer, launches the sale by
stating a suggested opening bid, a beginning price, or a
reserve for a valuable antique up for bid. The
auctioneer then takes progressively higher bids from
the audience. There are already several bidders in
attendance who have participated in the auction.
There are other bids as well, though, who will also be
taken into account.
These are customers who are interested in the rare
antique and can place online or telephone bids. In this
way, we can tell that, not every bidder has to be on the
floor in order to take part in the auction but can also
be able to participate in it from their homes or any
other place. However, the amount of money is huge
factor in this. The minimum increment of bids is often
set by Joseph, the auctioneer, who frequently increases
it as bids rise.
Let's say that there are all kinds of bidders. Bidders
who will pay the highest price, those who will offer the
lowest price, and those who might offer half of the
auctioneer's minimum bid. The top bidder at any one
time in this auction is regarded as having the standing
bid, which can only be overridden by a larger offer
from a rival buyer.
Let's now talk about the bidder who has the potential
to acquire the rival buyer. Within the time allotted by
the auctioneer, he or she may contest the standing bid.
As a result, the standing bid wins, and the valuable
artifact is sold to the highest bidder for the amount of
their bid.
WHEN ITEMS ARE LEFT UNSOLD:
There are instances when every bidder who
participated in the auction may feel that the price of
the rare antique makes it prohibitively expensive to
buy. Even the item's initial price can be too expensive
for all of the bids right away. If no bidder accepts the
starting price in this instance, Joseph, the auctioneer
will either need to drop the starting price
incrementally or will be able to accept bids below the
starting price. In the worst case, the seller or rules of
the auction house may opt not to sell the antique at all
if none of the bidders really wind up to buy it.
4) Open descending-bid auctions (Dutch
auctions)
The terms clock auction and open-outcry
descending-price auction have both been used to
describe a Dutch auction. It describes a certain
kind of auction in which the auctioneer sets the
starting offer extremely high before gradually
lowering it until a bid is submitted. Without any
more bidding wars, the initial bid wins the
auction (as long as the price is higher than the
reserve price).
EXAMPLE OF OPEN DESCENDING-BID
AUCTIONS (DUTCH AUCTIONS):
A company vehicle will be put up for auction by
Rovari, a car dealership company, with a starting
offer of $15,000. They just made the decision to
get rid of the cars that had been taking up a lot of
place in their showrooms. To create place for
newer vehicles and receive some return for their
investment, Rovari made the decision to sell one
of the current vehicles at auction. As a result,
they will also have the chance to put the money
they made from the auction back into their
company in order to generate more income in
the future.
If the opening offer is rejected, Rovari would
gradually lower the price by $1,000s. When the
car's price hits $10,000, a certain bidder swiftly
accepts the bid and pays $10,000 for the vehicle
that Rovari had put up for auction.
This bidder felt that the price was reasonable
and that someone else might soon bid. In
conclusion, Rovari receives $10,000 in exchange
and is able to remove the car from their
showroom that was occupying an excessive
amount of space.
EXAMPLE OF OPEN DESCENDING-BID
AUCTIONS (DUTCH AUCTIONS) FOR INITIAL
PUBLIC OFFERINGS:
A public offering in which shares of a firm are
sold to institutional investors and typically also
to retail investors is known as an initial public
offering (IPO) or stock launch.
1) Suppose, one investor offers $200 for 200
stock shares while another investor offers $95 for
500 shares.
2) All the bids are submitted.
3) The placement is assigned to the bidders in
order of highest bid to lowest bid, continuing
until all shares are assigned.
4) Consideration of the fact that the price each
bidder pays is determined by the lowest bid
made by allocated bidders.
5) The last bid will be accepted.
From this process, we can also conclude that if
your bid was the last one to be accepted, you
would only be required to pay $95 for the 2000
shares, even if you had offered $200 for your
2,000 shares.
For thousands of years, communities have
utilized auctions as the most popular technique
for allocating scarce resources, and for good
reason. Auctions are essential to the distribution
of limited resources in a market economy,
whether they are used for the sale of crops or the
auctioning of spectrum waves. Traditional
auction theory has focused a lot of its attention
on single-item sealed-bid auctions. In auction
theory, it is common practice to rank auction
designs based on either efficiency or revenue
maximization. Each year, an enormous amount
of commodities are exchanged at auction. And
there's always the chance that a buyer will find
something at an auction that is cheaper. At
auctions, customers occasionally discover
uncommon artifacts. Individual buyers and
sellers do not engage in direct negotiations on
auction markets.
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