Auction Theory

Looking into auction theory and the information asymmetries, among other problems, faced.

Building on the previous article about information asymmetries, one specific example in which this can happen are auctions – there can be information asymmetries between buyers themselves, as it is unknown how much each potential buyer is willing to pay. So, the buyers do not know how much to bid to outcompete the others. This is especially true for silent auctions where a potential buyer does not know if their bid is the highest until the item has been sold, after which they will no longer be able to buy it. This can seem unfair as they may have been willing to pay more than the person who won but was not able to compete, and this is one of the main problems faced in Auction Theory, which is a field of economics revolving around auctions and how to make them better so that sellers get the best deal possible. Buyers can reasonably bid for a product. The problem of not knowing how much to bid alongside sellers not getting the maximum amount of money possible in the auction means that auctions are unfair to both parties. From one perspective, auctions do not seem rational to take part in. The 2020 Nobel Prize in Economics was awarded to Professor Paul Milgrom and Professor Robert B. Wilson for their contribution to solving this issue by providing a new alternative auction system that adjusted for the shortcomings of the traditional and more popular English and Dutch auction systems. The English auction system is usually imagined when discussing auctions –  bidders compete to try and outbid each other until only one bidder is left who is still willing to pay the new price. This is the ideal situation for the buyers as they can try and get the product for a lower price than it would usually be sold. They also can compete with other potential buyers, meaning they will not miss out on the opportunity simply because someone else got there first. However, this is not beneficial for the seller in most cases, as often the winner may be willing to pay more for the item, but as the others stopped bidding, they were able to get it for cheaper, which means the seller did not get as much money as they could and should have.

There is also the issue of bidder collusion, where potential buyers may be paid off not to bid, meaning that one person can get the item at the starting value. So, the seller loses a large proportion of potential profit. Although laws and regulations prevent these situations from occurring, these are only effective for major auctions with many valuable items. Often, it isn’t easy to identify and correct this situation in a simple auction for a house, so people often get away with it at the seller’s cost. The Dutch system works oppositely, with the opposite disadvantages. The auctioneer names a high starting price and then lowers the price until someone bids. The first person to bid will get the item, and this way, the seller is more likely to get the best possible price. On the other hand, this is not beneficial for potential buyers as they may have been willing to pay a higher fee than it was sold for but was trying to save some money. So due to uncertainty on when to bid, they lost out and can no longer compete to buy the product, and they may also discover that the other buyers would only pay much less for the item than what they got it for, and so they massively overpaid.

A critical difference between the two is that multiple people bid in the English auction, but you must be the first to raise your hand to win in the Dutch system. This means that people may be less likely to bid in the Dutch auction as they are unsure whether they are overpaying or even worth the cost and may only settle for a lower price. In contrast, other buyers will also be bidding simultaneously for similar prices in an English auction, which confirms the item’s common value and that the price paid is fair, so they will be more likely to participate. This led to economists concluding that both auctions result in a similar price for the seller, and so although it may seem like the Dutch system can pay the seller more, the pressure from the Dutch auction and herd mentality of the English auction means that the prices from both reach an equilibrium, which is ultimately worse for the seller as they will never be able to get the best possible price for their product. This is another challenge that Professor Robert B. Wilson and Professor Paul Milgrom overcame with their Nobel Prize-winning model called the ‘Simultaneous Multi-Round Auction’, which can be run through the website created by Milgrom called ‘Auctionomics’. This would allow bidders to place their initial prices in a silent auction and open the auction for all bidders to see the current highest bids and try to outcompete them or withdraw their offer if they cannot compete. Then the auction moves on in multiple rounds until no withdrawals or bids are made. This allows potential buyers to access all the products they want to buy at once to prevent bidder collusion and remove the pressure of a Dutch auction by seeing how other bidders are offering similar prices to them in the competing rounds, so they are more likely to bid higher. It also stops corruption as all bids are made public, and it is an open auction that does not allow special treatment to any individuals. This system has been used multiple times in the U.S, as well as many other major developed countries, to allocate billions of dollars worth of goods or services that have a national impact, such as radio towers and natural resources somewhat to let them be utilised efficiently and effectively as well as to generate revenue for the government that can be used to develop other national projects.


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