Video Title: The Audio Podcast

Professor: Okay, so now let's come to this concept of second price sealed bid auction and this seems
a little counterintuitive to me. So, what I understand is that the highest bidder gets the object
whatever is being auctioned but pays the price that the second-highest bidder bids. Right? This is very
counter-intuitive to me. Can you explain this, why this kind of auction is used?

Mayurakshi: Can I borrow your pen to explain this? Let us assume that this pen your true valuation of
this pen is ten rupees.

Professor: So, which means that my willingness to pay for this pen or WTP is 10 rupees.

Mayurakshi: Yes.

Professor: Which means that even if you sell it to me at 10 rupees and one paise, I should not buy it
up to 10 rupees, I should buy it below 10 rupees also I should buy it.

Mayurakshi: Yes. So, it is the maximum price that you are willing to pay to buy this pen.

Professor: Great. So, I'm willing to pay up to 10 rupees for this pen and but when you are auctioning
it, it is very obvious that I should not pay even one paisa more than 10 rupees. But what I can't
understand is I will be very happy paying 8 rupees or 9 rupees for this pen. I just have to win, right? If
I pay anything up to 10 rupees and win this pen it is kind of like savings or profit for me, why should
not I bid lower than my willingness to pay.

Mayurakshi: So, there are other bidders with you, you do not have complete information. You do not
know what they are bidding? What is their willingness to pay?

Professor: So, if there are 100 other people in the rooms who have all put in a sealed bid, I have no
idea what they are going to bid.

Mayurakshi: So, what is the maximum that you can afford?

Professor: That is 10 rupees.

Mayurakshi: That is 10 rupees. So, you're going to pay 10 rupees, right? So that no one outbids you,
right?

Professor: I see. So, which means that is the second-highest bid is 9 rupees and I have bid 10 rupees
then I make a profit of saving of one rupee and it could go up to one paisa if somebody bids 9 rupees
99 paise.

Mayurakshi: And you are better off.

Professor: On the other hand, if I lose the bid if I get outbid, it means that somebody would have bid
more than 10 rupees which I didn't want to bid anyway. It would have been loss-making for me. So,
this is where I'm actually kind of economics is forcing me to bid my true willingness to pay, right? So,
now you see, there is actually a very complicated economic theory where you can, mathematically
sure that you are best possible bid in a second price sealed bid auction is your true valuation of any
object and in our terminology, that is your willingness to pay. Now, believe it or not, there is an
economist called Vickrey, who won the Nobel Prize for showing exactly this. And the second price
auction has many other properties that some other auctions don't have. We will not be going to

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auction theory here, but the second prize auction is once such auction where the best possible move
for you is to bid your so-called true valuation without strategically increasing or decreasing. So how
do we find out willingness to pay from a second price auction? Very simple. You conduct the second
price auction with a large number of people and then after that, the auctioneer just gives your
distribution of what bids you have made. And if that sample of people participating in the auction is
statistically representative, then very much you can say that it very closely resembles the real
distribution of true willingness to pay.

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