Introduction to auctions: What is an auction?

I intend to get more deeply into auction theory in the coming months. To start off with I will have a quick look at what an auction is.

The normal definition of an auction is that it is a way to sell something through getting bids from potential buyers where the outcome of the auction is determined solely by the bids made.

This means that an auction has two features:

1 – an auction can be used to sell anything, it is described as being ‘universal’

2 – the identity of the bidders does not matter, it is the size of the bids that determines the outcome rather then who is bidding. Auctions are therefore described as ‘anonymous’.

I think it is always useful to go back to the basic definitions that underly the theory to make sure that we understand the limitations of the theory that derives from them.

The idea that an auction can be used to sell anything is pretty hard to argue with. There are variants for auctions selling multiple units of the same item, or auctions selling divisible items but they are all selling something.

The second assumption is not quite so clear cut. Is it really the case that the identity of the bidders make no difference to the outcome of the auction? If I was bidding against a multi-millionaire who I knew was desperate to win the auction then that might affect my behavior. Maybe I would not bother bidding because I know that they will outbid me regardless. Or perhaps I would bid the price up higher just to make them pay a higher price.

This is seen in online penny auctions where players develop a reputation that they will never drop out and then use that to their advantage to win subsequent auctions as no-one is prepared to take them on.

This is an area where some behavioural study would be needed but it is enough for us to notice that the normal assumption is that the bidder’s identity doesn’t matter but this is not necessarily the case in reality.

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