Micro Ch 17

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Chapter 17 Auctions and Bargaining


17 Auctions and Bargaining

Chapter Outline

17.1 Auctions17.2 Bargaining



Key Ideas1. Auctions are increasingly used to sell goods

and services.2. There are four major types of auctions:

English, Dutch, sealed bid first price and sealed bid second price auctions. Economic theory predicts that under certain assumptions they yield identical revenues for the seller.



Key Ideas

3. Bargaining is another frequent way that goods and services are exchanged.

4. Bargaining power importantly determines the terms of exchange.



Evidence-Based Economics Example: How should you bid in an eBay auction?


17.1 Auctions

Auction

Market process in which potential buyers bid on a good and the highest bidder receives the good


17.1 Auctions

Auction item: Two Oakland Raiders tickets being bid upon by five bidders

Assume that bidders have private values that are unknown to other bidders and seller.

Exhibit 17.2 Bidder Valuations for Raiders Tickets


17.1 AuctionsTypes of Auctions

Auctions vary by

• How bids are placed

• How price is determined



How bids are placed:

Open outcry auctionBids are public

Sealed bid auctionBids are private so no bidder knows another’s

bid



How price is determined:

Sealed bid first-price auction

Bidders privately submit bids at the same time with highest bidder winning item and paying amount of that bid



How price is determined:

Sealed bid second-price auction

Bidders privately submit bids at the same time with highest bidder winning item and paying the second highest bid



Four major types of auctions:

1. Open-outcry English auction2. Open-outcry Dutch auction3. Sealed bid first-price auction4. Sealed bid second-price auction


17.1 AuctionsOpen-Outcry English Auctions

English auction

Open-outcry auction in which the price increases until there is only one standing bid. The last bidder wins the item and pays the bid.



What is your optimal strategy to get the tickets?

Bidding starts at $25.Everyone will be willing to bid.

Bidding goes up to $50This is Eli’s limit so he will drop out.

Bidding goes to $100Dalton is not willing to keep bidding since

$100 is his limit.



Bidding goes up to $150This is Carol’s limit so she drops out.

Only Billy and Ashley are left.

Assume Ashley bids $200. Billy will not bid because $200 is his limit—he is not willing to go over $200.

Therefore, Ashley wins and pays $200 -- $50 less than her maximum amount.



The best strategy for everyone is to bid up to their highest value, which means the person with the highest value will get the item.

= dominant strategy


17.1 AuctionsOpen-Outcry Dutch Auctions

Dutch auction

Open-outcry auction in which the price decreases until a bidder stops the auction. The bidder who stops the auction wins the item and pays that bid.



What is your optimal strategy to get the tickets?

Bidding starts at $500.No one bids since this is above everyone’s

limit.Auction price then is lowered…down to $250.

If you are Ashley, what do you do?



Let’s assume Ashley is risk-neutral. Ashley knows how many bidders there are, but doesn’t know their highest values.

Optimal bid = 4/5 ($250) = $200


17.1 AuctionsSealed Bid: First-Price Auction

Unlike open outcry auctions, sealed bid auctions are private and bids are submitted simultaneously.

If you are Ashley, what do you bid?


17.1 AuctionsSealed Bid: Second-Price Auction

This method is unique—the winner does not pay his/her bid. Instead the winner pays the second-highest bid.

What should Ashley bid?



Ashley has 3 choices:

1. Bid more than $2502. Bid less than $2503. Bid exactly $250



Should she bid more than $250?

First outcome: the second-highest bid is lower than $250.

If this is the case, she would have done just as well by bidding her value—she gains nothing by bidding more than her value.



Should she bid more than $250?

Second outcome: the second-highest bid is higher than $250.

If Ashley “wins” she has to pay an amount that is greater than her value, leading to negative surplus.



Should she bid less than $250?

First outcome: other bids are very low, e.g., highest bid is $100

Ashley could win the auction by bidding her value and still pay $100. No advantage to bidding below $250.



Should she bid less than $250?

Second outcome: other bids are close to her value, e.g., highest bid is $200.

If Ashley bids less than $200, she loses the tickets, even though she values them the highest.



Should she bid exactly $250?

Bidding exactly her value means she gets the tickets and gets some surplus. If everyone bids his or her value, she will get the tickets for $200, again getting $50 in surplus.


17.1 AuctionsThe Revenue Equivalence Theorem

Exhibit 17.3 Summary of Revenue Determination in the Four Auction Types



Evidence-Based Economics Example: How should you bid in an eBay auction?


17.2 Bargaining

There is another example of markets where the price is not fixed—markets where bargaining occurs.


17.2 BargainingWhat Determines Bargaining Outcomes?

Bargaining power

The relative power an individual has in negotiations with another individual



Bargaining power has two components:

1. The cost of not coming to an agreement

2. The influence of one participant over the other



You have landed your dream job right after graduation—you start Monday morning.

On Friday, your 15-year-old car dies. You see an ad for a perfect car in your price range, and you race to the used car lot.Four other potential buyers are also there.


17.2 BargainingBargaining in Action: The Ultimatum Game

Exhibit 17.4 The Ultimatum Game


17.2 BargainingBargaining in Action: The Ultimatum Game

If you were the Responder, would you accept one penny?


17.2 BargainingBargaining and the Coase Theorem

This is Adam and Barb. Adam wants a divorce; Barb does not.



If they live in a state that requires only one person to seek a divorce, who has the bargaining power?

Can Adam be persuaded to stay married?



If they live in a state that requires two people to seek a divorce, who has the bargaining power?

Can Barb be persuaded to divorce?



Exhibit 17.5 The Coase Theorem in Action

Micro Ch 17

Economy & Finance

Transcript of Micro Ch 17