PowerPoint Slides © Michael R. Ward, UTA 2014

Auctions Auctions are simply another form of competition, like price competition or bargaining CarBargains is one company that uses auctions to help car buyers. In these auctions, though, sellers, not buyers, are competing Local car dealers offer prices to a single consumer in a sealed-bid auction Auctions set a price and identify the high-value buyer or low-cost seller Auctions are often used in combination with bargaining, e.g., first an auction is used to identify the high-value buyers and then there is a negotiation over the final price Econ 5313

Auction Experiments Put name and amounts for six separate auctions Auction off a Beautiful Coffee Mug 1.First-Price Sealed Bid 2.Oral Auction Sealed bid auction off a Twenty Dollar Bill 1.The whole class can participate 2.The first row participates 3.Two bidders participate What do you expect to happen to the value of the winning bid and the average bid in these auctions? Econ 5313

Oral or English Auction Bidders submit increasing bids until only one bidder remains The item is awarded to this last remaining bidder Example: Suppose there are five bidders with values equal to {$5, $4, $3, $2, $1}. The $5 bidder will win with a bid only slightly over $4 The “price” or winning bid is $4 (or slightly above) The winning bidder is willing to pay $5 but doesn’t have to, so the losing bidders determine the price in oral auctions Auctions identify the high-value bidder (“efficiency”) and set a price for an item, with no negotiating necessary For these reasons, economists love auctions Econ 5313

Auction versus Posted-price Example A retail store is unsure whether they should price high ($8) or low ($5) for a certain item If the store prices high, they sell to only high-value buyers (half the time) If the store prices low, they sell to all customers at a lower price If MC = $3, then pricing high is preferable Price at $8 => (.5)×($8-$3) = $2.50 Price at $5 => (1.0)×($5-$3) = $2.00 Econ 5313

Auction versus Posted-price If the store uses an auction instead, and two bidders show up with values $8 and $5 – meaning there is again a 0.5 chance of selling to a high-value costumer – what will the revenue of the sale be? Expected winning bid = 0.75×$ ×$8 = $5.75 Econ 5313 Bidder 1Bidder 2ProbabilityWinning Bid $5 0.25$5 $80.25$5 $8$50.25$5 $8 0.25$8

Auction versus Posted-price Three bidders? Expected winning bid = 0.5×$ ×$8 = $6.50 More bidders improves the expected winning bid Econ 5313 Bidder 1Bidder 2Bidder 3ProbabilityWinning Bid $ $ $ $ $ $ $ $8

Vickrey or Second-price Auction A sealed-bid auction in which the item is awarded to the highest bidder, but the winner pays only the second- highest bid This at first seems counterintuitive – why leave money on the table? Second-price auctions encourage bidders to bid more aggressively William Vickrey and James A. Mirrlees shared the 1996 Nobel Prize in Economics for their work inventing the Vickrey auction and establishing that there is no difference in outcome between an oral and second-price auction Econ 5313

Vickrey or Second-price Auction Because the winning bidder pays the price of the second- highest bid, bidders are willing to bid up to their values, so the outcome is the same as an oral auction Second-price auctions are easier to run than oral auctions because the bidders can bid remotely and asynchronously (at different places and times) Why are eBay auctions equivalent to second-price auctions? Why does eBay use second-price auctions? Econ 5313

Sealed Bid Auctions The highest bidder gets the item at a price equal to the highest bid These auctions present a difficult trade-off for bidders: A higher bid reduces the profit if you win, but Also raises probability of winning Bidders balance these two effects by bidding below their values (“shading”) Experience and knowing the competing bidders are the keys to these auctions, but in general, bid more aggressively – shade less – if the competition is strong The $20 bill Auction? Econ 5313

Bid-Rigging Example: an oral auction with bidder values of {$5, $4, $3, $2, $1} Suppose that in this auction the two high-value bidders have formed a bidding ring (also known as a cartel) The two decide NOT to bid against each other, so the cartel wins the item by outbidding the non-cartel members, i.e., price= $3. The cartel makes a profit of $1 which typically is split evenly between members Bid-rigging is a criminal violation of antitrust laws in the US and many other countries In one type of bid-rigging, cartel members re-auction the items won in a second-auction to cartel members in a second or “knockout” auction Econ 5313

Bid-Rigging Another type of collusion is known as a bid-rotation scheme. This scheme uses quid pro quo bidding behavior Bidders in these cartels submit weak bids or refrain from bidding against each other until it is their turn to “win” In a bid-rotation scheme each cartel member must wait for his turn to win – a weakness that leaves these schemes vulnerable to cheating Collusion is more likely in oral auctions Why? Collusion is more likely in small, frequent auctions Why? Econ 5313

Frozen Fish Conspiracy After this cartel was broken the price of fish dropped 23% Investigators “backcast” from the competition period into the collusive period to determine the cartel’s effect, i.e., what the price would have been, “but for” the conspiracy Econ 5313

Lessons from Bid-Rigging The government is frequently the victim of bid-rigging schemes Learning from the government’s experience, some tips to avoid collusion: Do not rely on purchasing agents (those running the auction) who have little interest in buying at a low price. Instead, reward agents for making good (high-quality and low-price) purchases Do not entangle purchasing agents with masses of red tape. Instead, permit them to negotiate (e.g., to bargain with the bidders) if they suspect bid rigging But beware of patronage Do not use the procurement process to further a social agenda (small business set-asides, public lands, national defense, etc.) that is irrelevant to the goal of purchasing goods at low prices Econ 5313

Lessons from Bid-Rigging Keep cartels in the dark so that it is difficult for them to organize and to punish cheaters Do not hold open auctions Do not hold small and frequent auctions Do not disclose information to bidders—do not announce who the other bidders are, who the winners are, or what the winning bids are Econ 5313

A Common-value Auction The value is the same for each bidder, but no one knows what it is. Each bidder has only an estimate of the value. These auctions exhibit the “winner’s curse” If you win, you learn that you were the one who had the highest and most optimistic estimate of the unknown value of the item Bidders should reduce their value estimates to protect against this If you are the auctioneer, release info to mitigate winners’ curse. Winner’s curse is worse when More bidders Other bidders have better information Auctioning the jar the? Econ 5313

Winner’s Curse To avoid the winner’s curse bid less aggressively as the number of bidders increases In common-value settings, oral auctions return higher prices than sealed-bid auctions because oral bids reveal information But oral auctions are more vulnerable to collusion Why do bidders wait until the last minute of the auction to submit bids on eBay? Econ 5313

From the Blog Chapter 18 Lots of pictures reduce winner’s curse Reserve Prices Airline Upgrades Regulation Patronage and Bid-Rigging Econ 5313

Main Points Oral Auctions – highest bidder pays his bid Second Price Auction – highest bidder pays his second highest bid Strategically Identical Sealed bid Auction – must shade bids Beware of Bid-rigging Open, small, frequent auctions in which winners are revealed Common Value Auction – item of same value to all bidders Associated with winner’s curse Avoid with winner’s curse Assume you are the most optimistic Release lots of info Econ 5313