Introduction to Auctions

A short history of auctions

• 500 B.C. Babylon: women were auctioned off as wives (Herodot)

• ~150: Roman soldiers sold war plunder at auction.

• 1744: Sotheby's was created and Christie's in 1766. (mainly art)

• 1887: Sale of fruits and vegetables in the Netherlands through auctions

• 1995: eBay was launched

• 2000/01: UMTS - G3 auction for radio spectrum in Europe (revenue of

>50bn EUR)
 Use of auctions today
An auction is a market institution with an explicit set
of rules determining resource allocation and prices
on the basis of bids from the market participants.
(McAfee, McMillan, 1987) e.g. used for

• Treasury bills

• Drilling rights on oil fields

• Privatisation of firms and other assets

• Takeover battles

• Procurement

• and many more

 Why selling through auctions

• Price Setting - difficult to determine the highest

willingness to pay, however lower search cost for
customer

• Lottery: not efficient since not necessarily the

participant with the highest value for the good
wins

• Contract awarding (Beauty Contest): might easily

yield a political outcome and might lower the
chance of getting new entrants to the market.
 Four basic types of auctions

• Ascending bid (English) auction the price is

successively raised until only one bidder remains, and that bidder wins at the
final price.

• Descending bid (Dutch) auction the price is

lowered continuously; the first bidder calling out wins the object at this
price.

• First Price sealed bid auction each bidder

independently submits a single bid, without seeing others’ bids, the object is
sold to the bidder who makes the highest bid; at a price of his bid.

• Second Price sealed bid (Vickrey) auction

each bidder independently submits a single bid, without seeing others’ bids,
the object is sold to the bidder with the highest bid at the second highest
bid.
Strategical equivalent auctions I

• Ascending bid (English) auction the price is

successively raised until only one bidder remains, and that bidder wins at the
final price.

• Descending bid (Dutch) auction the price is

lowered continuously; the first bidder calling out wins the object at this
price.

• First Price sealed bid auction each bidder

independently submits a single bid, without seeing others’ bids, the object is
sold to the bidder who makes the highest bid; at a price of his bid.

• Second Price sealed bid (Vickrey) auction

each bidder independently submits a single bid, without seeing others’ bids,
the object is sold to the bidder with the highest bid at the second highest
bid.
Strategical equivalent auctions II

• Ascending bid (English) auction the price is

successively raised until only one bidder remains, and that bidder wins at the
final price.

• Descending bid (Dutch) auction the price is

lowered continuously; the first bidder calling out wins the object at this
price.

• First Price sealed bid auction each bidder

independently submits a single bid, without seeing others’ bids, the object is
sold to the bidder who makes the highest bid; at a price of his bid.

• Second Price sealed bid (Vickrey) auction

each bidder independently submits a single bid, without seeing others’ bids,
the object is sold to the bidder with the highest bid at the second highest
bid.
 Truth telling a dominant strategy
Second Price Auctions

Strategic under-bidding Strategic over-bidding

price (three cases) (three cases)

my bid opponents bid my loss my profit

Truth telling a dominant strategy
Truth Telling is the dominant strategy for Second Price
auctions => bid shading is not a good (dominant)
strategy.

What happens in a First Price auction? Truce telling can

not be a optimal strategy since:

for a bid b=vi the expected revenue is 0; E[r]=0

Therefore the optimal bid b* must be smaller than

bidders i true value vi => bid shading is a good
(dominant) strategy.
 Strategy for first price auction
Recall the first price auction: all players state a bid, and the winner is the player with
maximum bid, and has to pay his bid as price.

Assumptions:
- there are n>=2 bidders
- every bidder draws (independently) a valuation v from [0,1]
- if bidder i submits the highest bid b* she realizes a economic gain of vi-b*

Claim: best strategy for bidder with value vi is to bid:

(n !1)
vi
" bn %
n !1 n " bn %
n !1

Proof: probability of winning for bid b is: $ ' and the expected value: (v i ! b)$ '
# n !1 & # n !1 &
First derivative with respect to b (set equal to 0 to find the maximum) gives:
n !1 n !1
" bn % " n %
!$ ' + (v i ! b)(n !1)b n !2 $ ' =0
# n !1 & # n !1 &
which reduces to: !b + (v i ! b)(n !1) = 0
(n !1)
b = vi
n
 Strategy for first price auction

In a First price auction the dominant strategy is given by:

(n !1) 1
optimal bid is b = vi in case of n=2 bi = v i
n 2
According to the Revenue Equivalence Theorem (here without
proof): Second and First Price auctions generate the same
revenue for bidder and auctioneer. If so, why bother about
auction design at all?
Auction design needs to consider

• Available time to sell the goods (fish,

flowers, tobacco) =>Dutch auction
• Risk of collusion (limited amount of buyers)
=> First Price auction
• Predatory behavior (a strong bidder
participating might discourage new
entrants) => Sealed bid auction
 Collusion

First Price Auction Second Price Auction

loss
price

profit

agreed price agreed price

my bid opponents bid my loss my profit

 The Winners Curse
Interdependent valuation

• Bidding on drilling rights on oil fields

• All bidders form their estimate value vi

according to their own geological

evaluation
• Each bidder makes a single bid
• If you win you probably overestimated the
true value of the oil field
 Underlying assumptions

• All bidders are risk neutral

• private values are independent drawn from
a uniform distribution
The marriage market