Game Theory, Nobel Prize, & Auctions - Auction Primer Series ? Part 1

William Vickrey, highly regarded as the founder of auction theory, was an economics professor at Columbia University when he published two papers outlining his views on auctions:

"Counterspeculation, Auctions, and Competitive Sealed Tenders", 1961, Journal of Finance

"Auction and Bidding Games", 1962, Recent Advances in Game Theory

In 1996 he received a Nobel Prize "for fundamental contributions to the economic theory of incentives under asymmetric information." It's important to understand that asymmetric information is an essential component of auctions, where potential buyers have varying levels of knowledge about the value of the item.

Although Vickrey considered his work on auctions as "one of my digressions into abstract economics, at best of minor significance in terms of human welfare", to those of us who work with online auctions, much of what he outlined is useful to understanding our marketplace.

Vickrey identified 4 general types of auctions:

English
Dutch
First-price sealed bid
Second-price sealed bid

English Auctions
The most common type of auction is the English Auction, although it may also be known as an ascending price auction. In ascending price auctions each subsequent bid is higher than the previous one. This is the most popular type of auction for single items.

Although traditional ascending price auctions use a "soft close" format - where bidding continues until a final bid is placed, the majority of today's on-line auction sites use the "hard close" format - also known as a 'time interval" auction having a set time limit, regardless of ongoing bidding. It's important to note that in a "soft close" format, bid snipping, that is bidding during the last few seconds or minutes on an item, is eliminated since the auction stays open as long as bids are being made.

In an attempt to minimize bid snipping and provide more of a "soft close" characteristic to their "hard close" auctions, eBay allows bidders to use "proxy bidding". In proxy bidding, a bidder enters the highest price they are willing to pay for an item when they first bid. The bid begins at the lowest possible level and increases automatically only if their original lowest bid has been beaten. For more in-depth information on the "proxy bidding capability on eBay go here.

http://pages.ebay.com/help/buy/proxy-bidding.html

Amazon.com currently offers a feature for their auctions called "Going, Going, Gone." The Going, Going, Gone" feature extends the end of an auction for 10 minutes if a bid is placed effectively creating a "soft close". For more information on the "Going, Going, Gone" feature on Amazon go here. http://www.amazon.com/exec/obidos/tg/browse/-/1161360/103-1666189-8415007#going-gone

From the buyers standpoint a "hard close" format is preferable since they may be able to make a final bid before others can react, possibly winning the auction at a lower price.

For sellers, a "soft close" format provides an opportunity to realize the maximum price for an item by removing the time restrictions for an auction. As long as bidders are bidding the auction remains open.

Dutch Auctions
As you may have guessed, the concept of the Dutch auction originates in the Netherlands. Unlike English auctions which utilize ascending price methods, Dutch auctions are descending price auctions and are commonly used when multiples of the same items are to be auctioned. In a Dutch auction the bidding starts at a relatively high price which is driven progressively downward by bids.

As an example of a Dutch auction let's say you had 10 items you wanted to sell for $20 each.

Bidder A bids $18 for 6 items
Bidder B bids $17 for 5 items
The final result is:
Bidder A would receive 6 items for $17 each
Bidder B would receive 4 items for $17 each

Please note that most Dutch auctions allow bidders to refuse an order for a lesser number of items than what they bid on. A "soft" or "hard close" format may be used in Dutch auctions although the most common is the "hard close".

First-price Sealed Bid Auctions
Sealed bid auctions differ from the English and Dutch in as much as the bids are not announced to other bidders. The individual bid is only know to the bidder and the seller. This type of auction may be either buyer-bid, where the highest bidder wins the item and pays the amount of their bid, or seller-bid, where the lowest bidder sells the item and is paid the amount of the bid. This form of auction is common for construction contracting, military procurement, foreign exchanges, and other types of goods.

Second-price Sealed Bid Auctions
Another common name for second-price sealed bid auctions is Vickrey auctions (named after William Vickrey) There is a slight variation to the first-price auction for Vickery auctions. In a buyer-bid auction the highest bidder buys the item and pays the amount of the second highest bid. Or in a seller-bid auction, the lowest bidder sells the item and is paid the amount of the second lowest bid.

The above descriptions provide a general overview of the most popular auction types in use today. Depending on the auction website these general categories may include a number of variations and options such as reserve pricing, open or closed venue, multiple items, fixed price and lot listings to mention a few. Before entering any particular type of auctions make sure you study and understand the rules for that specific type of auction, as the rules may vary from website to website.

Steven Woodward is the owner, editor and publisher of the Auction Sellers Network (ASN); a web site for individuals and companies who are serious about utilizing the online auction marketplace for their business. In addition to topical articles, ASN provides an extensive resource center, news feeds and member forums. For more information, or to become a member, please visit us at http://www.AuctionSellersNetwork.com

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Game Theory, Nobel Prize, & Auctions - Auction Primer Series - Part 1