An auction is the process of buying and
selling things by offering them up for bid, taking bids, and then selling the item to the highest bidder. In economic theory
an auction is a method for determining the value of a commodity that has an undetermined or variable price. In some cases, there
is a minimum or reserve price; if the bidding does not reach the minimum, there is no sale (but the person who puts the
item up for auction still owes a fee to the auctioneer). In the context of auctions, a bid is an offered price.
Auctions are publicly seen in several contexts: in the antique business, where
besides being an opportunity for trade they also serve as social occasions and
entertainment; in the sale of collectibles such as stamps, coins, classic
cars, and fine art; in thoroughbred horseracing, where yearling horses are
commonly auctioned off; and in legal contexts where forced auctions
occur, as when one's farm or house is sold at auction on the courthouse
steps.
Although less publicly visible, the most economically important auctions are those in which the bidders are businesses or
corporations. Examples of this type of auction include:
- spectrum auctions, in which companies purchase licenses to use portions of the electromagnetic spectrum for communications (for cell phone networks, for example.)
- timber auctions, in which companies purchase licenses to log on government land.
- electricity auctions, in which large-scale generators and consumers of electricity bid on generating contracts.
- environmental auctions, in which companies bid for licenses to avoid being required to decrease their environmental
impact.
- debt auctions, in which governments sell debt instruments, such as bonds, to investors. The auction is
usually sealed and the uniform price paid by the investors is typically the best non-winning bid. In most cases, investors can
also place so called non-competitive bids which indicates an interest to purchase the debt instrument at the resulting price, whatever it may be.
Internet auctions, dominated by the wildly successful eBay, have become very popular.
The world's two largest auction
houses are Christie's and Sotheby's. The world's largest online auction site is eBay.
Auction catalogs are frequently printed and distributed before
auctions of rare and/or collectible items; these catalogs may be very elaborate works, with considerable details about the items
being auctioned.
Types of Auctions
Auctions are
- English auction: This is what most people think of as an auction. Participants bid openly against one another, with
each bid being higher than the previous bid. The auction ends when no participant is willing to bid further, or when a
pre-determined "buy-out" price is reached, at which point the highest bidder pays the price. The seller may set a 'reserve' price
and if the auctioneer fails to raise a bid higher than this reserve the sale may not go ahead.
- Dutch auction: In the traditional Dutch auction the auctioneer begins with a high asking price which is lowered until
some participant is willing to accept the auctioneer's price, or a predetermined minimum price is reached. That participant pays
the last announced price. This type of auction is convenient when it is important to auction goods quickly, since a sale never
requires more than one bid. The Dutch auction is named for its best known example, the Dutch tulip auctions; in the Netherlands this type of auction is actually known as a "Chinese auction". "Dutch auction" is
also sometimes used to describe online auctions where several identical goods are sold simultaneously to an equal number of high
bidders.
- Sealed first-price auction: In this type of auction all bidders simultaneously submit bids in such a way that no
bidder knows the bid of any other participant. The highest bidder pays the price he submitted.
- Sealed second-price auction, also known as a Vickrey
auction: This is identical to the sealed first-price auction, except the winning bidder pays the second highest bid
rather than his own. In theory, this is mathematically equivalent to the English auction, because in both the first-place bidder
receives the item at a price equal to the second-place bidder's willingness to pay.
- Silent auction: This is a sealed variant often used in charity events, but
involving the simultaneous sale of multiple items. Participants submit bids normally on paper, near the item. They may or may not
know how many other people are bidding or what their bids are.. The highest bidder pays the price submitted.
- Procurement auction: This kind of auction reverses
the roles of seller and buyer. The buyer puts out an RFQ for a given commodity and providers
offer progressively lower prices in hopes of getting the business. At the end of the auction, the lowest bid wins.
If more than one identical item is sold, there are two possible generalizations of the second-price auction. In a
uniform-price auction, all of the winning bidders pay the price submitted by the highest non-winning bidder. Bidders will not
typically bid their true value in a uniform-price auction with multiple units. In a Vickrey auction, the pricing rule is more
complicated, but preserves the property that bidders will bid their true valuation. It is also possible to auction each identical
item individually. Once each item has been priced, the winning bidder is entitled to buy the remaining goods at the same price.
Items the winning bidder opts not to purchase are auctioned again. This system creates a tension between the desire to hold back
on bidding since later items will almost certainly be cheaper, and the chance that by losing the first round of bidding all
possibility of purchasing will be lost.
Bidders in the traditional Dutch auction and sealed first-price auction will tend to underbid what they believe the item is
truly worth in hopes of getting the item for less, or in order to avoid the winner's curse. This behavior is known as bid shading. These two auctions are also theoretically equivalent,
but in practice Dutch auctions will produce less revenue than sealed first-price auctions (one of the important results of
Experimental economics)
Work in the theory of auctions contributed to Vickrey's 1996 Bank of Sweden Prize.
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