Auctions - Theory and practical application

Table of Contents

1. Introduction

2. Theoretical Approaches

3. Company Profile

4. Auction Design

5. Auction Implications
5.1. Revenues
5.2. Economic Efficiency

6. Conclusion

7. Bibliography

1. Introduction

For centuries, auctions are used to buy and sell goods and are regarded as an appropriate and effective method of a dynamical pricing procedure. In the last decades, economists are increasingly engaged in finding new, more efficient ways of auctions and developing the belonging strategies for bidders and sellers.

Nowadays the development of new technologies has a strong impact on the economic environment. Many traditional business styles are transforming or are already transformed into electronic transactions.

The increasing spread and usage of the Internet significantly influenced the auction business and caused a shift from the traditional forms to various online auction forms with a more extensive and flexible character according to product range, locations and payment methods.

The online auction pages are available 24 hours a day to people all over the world. In the last years, the reach of customers has dramatically expanded on a global basis, which indicates a clear threat to traditional auctioneers, who are loosing their market dominance.

In the following study primarily the theoretical approaches of auctions and its most common types are examined. Based on one of the major types, a recent Internet auction company is analysed. Main attention is paid to the auction design and the deductive implications on revenues and economic efficiency in general.

2. Theoretical Approaches

There are various possibilities of auctions but most of them are based on four main types, which were primarily analysed and further developed by the work of William Vickrey on auction theory in 1961 (See Vickrey, W., 1961, “Counterspeculations, Auctions and Competitive Sealed Tenders”, Journal of Finance, 16:1, pp 8 – 37).

The English ascending auction is the most common type, in which bidders raise each other’s bids until only one bidder remains. The strategy of each bidder is to bid until the price reaches the limit of willingness to pay more and to leave the auction then. The last bidder, with the highest valuation, finally wins the good and pays the price equal to the second highest valuation plus one marginal bid. This means the person with the highest willingness to pay obtains the good. It is a dominant strategy, which does not depend on the bids of the rivals.

In a Dutch descending auction, prices are announced in a descending order until one bidder agrees with the price. Hence, it is the opposite of the English auction since the first bidder will win the good. The bidder should bid below its actual willingness to pay. To which extend depends on the estimation of the willingness to pay of the rival bidders.

The first price sealed bid auction is similar to the Dutch auction. All bidders submit hidden bids until a certain point of time. Then the bids are opened and the highest or lowest bidder wins the good at the submitted price. Hence, the bid setting depends as well on the estimation of the valuation of the rivals.

Vickrey questioned if there is a possible sealed bid auction with a dominant character, similar to the English auction. He proposed a second price sealed bit auction, today also known as the Vickrey auction, in which each bidder applies a dominant strategy bidding to the own value without taken the valuations of the rivals into account. The winner finally pays the price submitted by the second highest bidder.

Due to wrong evaluations, the outcome of the first price sealed bid auction can be unfavourable. Therefore, the second price sealed bid auction is Pareto-superior.

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