10.1 Types of Auctions and Their Properties

Auctions come in various forms, each with unique characteristics. English auctions start low and increase, while Dutch auctions begin high and decrease. Sealed-bid auctions involve hidden bids, with first-price and second-price variants determining the winner's payment.

These auction types have different pros and cons. English auctions encourage competition but can be time-consuming. Dutch auctions are fast but may lead to underpricing. Sealed-bid auctions prevent collusion but can result in overbidding or lower seller revenue.

Types of Auctions

Types of auctions

• English auction (ascending-bid auction)
  • Bidding starts at a low price and increases incrementally as bidders compete openly against each other
  • Bidders drop out of the auction when the current price exceeds their maximum willingness to pay for the item being auctioned
  • The auction concludes when only one bidder remains, and that bidder wins the item by paying the highest bid price reached during the auction (art auctions, livestock sales)
• Dutch auction (descending-bid auction)
  • Bidding starts at a high price set by the auctioneer and decreases incrementally until a bidder accepts the current price
  • The first bidder to accept the current price wins the auction and pays that price for the item being auctioned
  • Dutch auctions are often used for perishable goods that need to be sold quickly (flower auctions in the Netherlands, fish markets)
• Sealed-bid first-price auction
  • Bidders submit their bids simultaneously in sealed envelopes without knowing the bids of other participants
  • The highest bidder among all submitted bids wins the auction and pays the exact amount they bid for the item
  • Commonly used in government contracts, mining rights, and real estate sales
• Sealed-bid second-price auction (Vickrey auction)
  • Bidders submit their bids simultaneously in sealed envelopes, just like in a sealed-bid first-price auction
  • The highest bidder wins the auction, but instead of paying their own bid, they pay the second-highest bid price submitted by another participant
  • This auction format is designed to encourage bidders to bid their true valuations without fear of overpaying (online advertising, spectrum auctions)

Properties of auction formats

• English auction
  • Open and transparent bidding process allows bidders to observe their competitors' actions and adjust their strategies accordingly
  • Bidders can gather information about others' valuations based on when they drop out of the auction
  • Encourages competition among bidders, which can lead to higher prices and increased revenue for the seller
• Dutch auction
  • Fast-paced and efficient auction format that can quickly determine the winner and price
  • Bidders have less information about others' valuations, as they must decide whether to accept the current price without knowing their competitors' intentions
  • Can result in lower prices compared to English auctions, as bidders may accept a price before it reaches their maximum willingness to pay
• Sealed-bid first-price auction
  • Bidders have no information about others' bids, which encourages them to bid close to their true valuations to increase their chances of winning
  • Bidders face a trade-off between increasing their probability of winning (by bidding higher) and maximizing their potential payoff (by bidding lower)
  • Can lead to overbidding and winner's curse, where the winner may pay more than the item's true value due to overestimating its worth relative to other bidders
• Sealed-bid second-price auction
  • Bidders have a dominant strategy to bid their true valuations, as they will only pay the second-highest bid price if they win
  • Reduces the risk of overbidding and winner's curse, as the winner's payment is determined by another bidder's valuation
  • Can generate lower revenue for the seller compared to first-price auctions, as the winner pays the second-highest bid rather than their own higher bid

Auction Efficiency and Revenue

Advantages vs disadvantages of auctions

• English auction
  • Advantages:
    1. Transparency in the bidding process fosters trust among participants
    2. Encourages competition, which can lead to higher prices for the seller
    3. Suitable for unique or high-value items where the seller is uncertain about the item's true market value (antiques, artwork)
  • Disadvantages:
    1. Time-consuming process, especially with many bidders or small bid increments
    2. Potential for collusion among bidders, who may agree not to compete against each other to keep prices low
• Dutch auction
  • Advantages:
    1. Fast and efficient auction format, particularly useful for perishable goods or time-sensitive situations
    2. Reduces the time and costs associated with prolonged bidding processes
    3. Suitable for auctions with a large number of identical items (agricultural produce, livestock)
  • Disadvantages:
    1. Less information available to bidders about others' valuations, which can lead to suboptimal bidding strategies
    2. Potential for underpricing if the auctioneer sets the starting price too low or decreases it too quickly
• Sealed-bid first-price auction
  • Advantages:
    1. Simple and straightforward auction format that is easy to understand and implement
    2. Prevents collusion among bidders, as they cannot coordinate their bids during the auction
    3. Suitable for situations where the seller wants to maintain confidentiality of bids (government contracts, mineral rights)
  • Disadvantages:
    1. Risk of winner's curse, where the winner overpays due to overestimating the item's value relative to other bidders
    2. May generate less revenue for the seller compared to English auctions, as bidders tend to bid more conservatively
• Sealed-bid second-price auction
  • Advantages:
    1. Encourages truthful bidding, as bidders have an incentive to bid their true valuations without fear of overpaying
    2. Reduces the risk of winner's curse, as the winner pays the second-highest bid price rather than their own higher bid
    3. Suitable for situations where the seller wants to prioritize efficiency over revenue (spectrum auctions, online advertising)
  • Disadvantages:
    1. Counterintuitive for bidders who may not fully understand the second-price rule, leading to suboptimal bidding
    2. Can generate lower revenue for the seller compared to first-price auctions, as the winner pays the second-highest bid price

Efficiency and revenue in auctions

• Efficiency
  • English and sealed-bid second-price auctions are generally considered efficient auction formats
    1. In these auctions, the bidder with the highest valuation for the item typically wins
    2. Encourages truthful bidding, which leads to the optimal allocation of resources to the party that values them the most
  • Dutch and sealed-bid first-price auctions can be less efficient
    1. Bidders may overbid or underbid due to the lack of information about others' valuations
    2. Can result in suboptimal allocation of resources, where the winner may not be the bidder with the highest valuation
• Revenue-generating potential
  • English and sealed-bid first-price auctions tend to generate higher revenue for the seller
    1. In English auctions, competition among bidders and the open bidding process can drive up prices
    2. In sealed-bid first-price auctions, the lack of information about others' bids encourages bidders to bid higher to increase their chances of winning
  • Dutch and sealed-bid second-price auctions may generate lower revenue for the seller
    1. In Dutch auctions, bidders have less incentive to bid aggressively, as they can wait for the price to drop before accepting it
    2. In sealed-bid second-price auctions, the second-price rule results in the seller receiving the second-highest bid price, which may be lower than the winner's actual valuation