MBA 6053 Columbia Southern University Value of Auctions in The Economy Paper


Auctions can be an important tool for selling goods and gathering information. Auctions are used in multiple venues including agriculture, eBay, and distressed asset sales. The seller does not have to worry about estimating demand and setting a price because the demanders will do that through the auction process.
Write an essay examining the value of auctions in the economy by addressing the following items.

Explain the difference between oral auctions and second-price auctions, including how they work and their results.
Use the expected value information to illustrate how having more bidders in an oral auction will likely result in a higher winning bid.
Explain how the number of bidders in a common value auction affects the outcome of the auction. Relate this to the effect on price in different market structures based on the number of producers.
Auctions lead to outcomes where buyers reveal their value for the products being auctioned. To successfully price discriminate, firms often rely on buyers revealing their value for products. Explain the conditions necessary for firms to be able to price discriminate.

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Uncertainty and Auctions
Course Learning Outcomes for Unit VI
Upon completion of this unit, students should be able to:
4. Evaluate strategic pricing decisions.
4.1 Describe the different types of auctions and the benefits of each.
7. Explain the implications of uncertainty in managerial decision-making.
7.1 Illustrate how to use expected value calculations to deal with uncertainty.
Learning Outcomes
Learning Activity
Unit Lesson
Chapter 18
Article: “Auctions Versus Negotiations: The Effects of Inefficient Renegotiation”
Unit VI Essay
Unit Lesson
Chapter 17
Unit VI Essay
Required Unit Resources
Chapter 17: Making Decisions with Uncertainty
Chapter 18: Auctions
In order to access the following resource, click the link below.
Herweg, F., & Schmidt, K. M. (2017). Auctions versus negotiations: The effects of inefficient renegotiation.
RAND Journal of Economics, 48(3), 647–672. Retrieved from
Unit Lesson
Expected Value
Examples in economics often assume a certain level of knowledge about the market, but this is often not the
case. Firms often face uncertainty in their decisions. Firms can use expected value to deal with uncertainty.
Expected value takes the probability of certain outcomes to arrive at a weighted average outcome. This
concept is best illustrated with an example.
Assume there are two possible outcomes for a game, such as flipping a coin. The outcome of heads is likely
to occur 50% of the time. If heads occurs, you win $1. The outcome of tails is likely to occur 50% of the time.
If tails occurs, you lose $1. What is the expected value of this game? We can determine this by simply
multiplying the payout by the probability that payout will occur and then summing the products for each
E[X] = ph * xh + pt * xt where X is the payout of the game, p is the probability, x is the payout for a particular
outcome and the subscripts h and t stand for heads and tails, respectively.
MBA 6053, Economics for Managers
In the example described: E[X] = 0.5 * $1 + 0.5 * $1 = $1
The expected value of the game is $1. You can imagine this simple example could be considerably complex
with different outcomes and multiple probabilities to match.
Obviously, a very important part of calculating expected value is to get the probabilities right. Decision-makers
should be aware that their probabilities are likely not correct. A good way to handle this is to run multiple
scenarios with different probabilities.
A growing opportunity for firms is to use data analysis to model probabilities. When using data, however, firms
need to be conscious of selection bias. Selection bias occurs when there is some difference in the data used
in the model probabilities that is not present in the target population. For a simple example of this, consider
exit polls at elections.
Pollsters survey voters coming out of voting booths to see how they voted and then make predictions on how
the election will turn out based on those surveys. What happens, though, if pollsters primarily go to urban
polling places to survey voters and do not go to rural polling places? If urban and rural voters vote the same
way, this is not a problem, but if there are fundamental differences between how urban voters vote and how
rural voters vote, then the surveys will be inaccurate. The surveys will likely be an accurate representation of
how urban voters vote but not how voting is cast as a whole.
Imagine a company making a similar mistake when marketing a new product. Uncertainty can never be
completely eliminated, but firms can take steps to try to make informed decisions and minimize potential
damage from unexpected events occurring.
You are probably most familiar with online auctions from websites like eBay. You might have gone to an
antique auction when you were younger (possibly dragged there by a parent or grandparent). If you live near
ranchers, you might have gone to a cattle auction. You have probably seen auctions portrayed on TV. You
might have seen a silent auction at a charity.
When sellers are unsure of the market value for their product, they can use auctions to make their sales.
Auctions allow customers to bid for the product and thus reveal their value. Auctions help sellers sell their
product and gain more information about the demand for their product. As seen from the previous paragraph,
auctions can take a variety of forms.
Auctions are often portrayed with somebody standing in front a room talking quickly and people in the
audience bidding quickly. These are called oral auctions or English auctions. In these auctions, people make
successive, increasing bids until only one bidder remains. The last remaining bidder gets the item at the last
price they bid. So ultimately, the price is set marginally above the value of the second highest bidder (that is,
a small amount above the value the second highest bidder holds).
A few points about oral auctions are listed below.
1. First, the greater losing bids there are in an auction, the higher the winning bid amount will be. This
point should make sense. The price will still go no higher than the highest valued bidder, but if the
closer other bidders are to valuing the product similar to the highest valued bidder, the higher the
winning bid will have to be.
2. Second, the more bidders there are in an auction, the more likely there will be other high valued
bidders. On eBay, for example, ten-day auctions return 42% higher prices than three-day auctions as
more time attracts more bidders (Froeb, McCann, Shor, & Ward, 2018).
3. Third, there is an important piece of information that is never disclosed in an oral auction: What is the
value the highest bidder holds for the product? All sellers know from an oral auction is that somebody
valued the product more than the product sold for.
An auction that addresses this problem is a second-price auction, also called a Vickery auction. Second-price
auctions are sealed-bid auctions, as opposed to the very public oral auction. There are also not multiple
rounds of the auction where bidders can outbid the last bid. This is a type of sealed-bid auction where bidders
MBA 6053, Economics for Managers
submit a bid without knowing the other bids. The product is still awarded to theUNIT
as in the oral
auction, but rather than paying their bid, they pay the second-highest bid.
A second-price auction encourages bidders to bid more aggressively and closer to their actual value (in fact
the optimal strategy is to bid exactly their value) for the good since they know they will not have to pay their
value, they will pay the bid of the second highest bidder. The outcome of the second-price auction is the same
as the oral auction (the ultimate price is equal to, or just above, the value of the second-highest bid), but there
are several benefits with a second-price auction that are not present with an oral auction.
1. First, as mentioned, bidders are encouraged to bid more aggressively. This aggressive bidding will
likely result in a higher price bid by the bidder with the second highest value. To see this, imagine an
oral auction where the second-highest value bidder infers from the highest-value bidder that they will
not be able to outbid the highest value bidder. The second-highest bidder might stop bidding early
knowing it is futile. Leaving the bidding early results in a lower ultimate price for the seller.
2. Second, second-price auctions can be conducted from anywhere and bidders do not have to be
present. Second-price auctions were popular with stamp dealers as far back as the 19th century
(Froebet al., 2018). Saving bidders the cost of travel (both explicit and opportunity) increases the net
value for the product to the bidders, which can also increase bids.
3. Third, and addressing the information shortcoming discussed with oral auctions, second-price
auctions give the seller information on the maximum value for their product since people, including
the winning bidder, will bid their maximum value.
Now, reading about a second-price auction might lead to the question, “Well, why not do everything with a
second-price auction but make the highest bidder pay the price they bid?” The problem with this approach is
that bidders are actually incentivized not to bid their maximum value. Since the winning bidder ultimately has
to pay their bid, they don’t want to pay their maximum value. If they did, they would be left with no profit (that
is, the difference between their value and what they pay) and bidders are technically indifferent between
winning and losing the auction. That means that bidders have an incentive to shade their bid. The seller would
not get accurate information on bidders’ value and would potentially get a lower price as all bidders shade
their bids.
Collusion and Irrational Behavior
Auctions can lead to attempts at collusion, called bid rigging. In bid rigging, a group of bidders work together
to keep down bids so that somebody from the group wins the auction at a bid lower than it otherwise would
have been. Bid rigging is more likely to occur in smaller, frequent auctions. The smaller size increases the
likelihood of communication between bidders and the frequency gives more opportunity to refine the rigging
and punish members of the group that attempt to cheat. Collusion is also more likely in oral auctions than
sealed-bid auctions, giving another benefit to second-price auctions over oral auctions. Finally, bid rigging is
more likely when the winner of an auction is identified. If bidders can win in secret, there is an incentive to
cheat (recall game theory from Unit IV).
Auctions can sometimes lead to irrational behavior. This irrational behavior is particularly true in oral auctions
where the desire to win overtakes the actual desire for the product being bid on. Oral auctions, more than
sealed-bid auctions, are likely to suffer from over bidding. For producers, though, this can mean a higher
winning bid. Bidding more than the value for the product can lead to the winner’s curse, where the winner of
an auction is actually worse off for having won the auction.
Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2018). Managerial economics: A problem solving
approach (5th ed.) [Vital Source Bookshelf version]. Retrieved from
MBA 6053, Economics for Managers
Learning Activities (Nongraded)
Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit
them. If you have questions, contact your instructor for further guidance and information.
In order to check your understanding of concepts
covered in this unit, complete the Unit VI Check
For Understanding activity.
Unit VI Activity Alternate Format PDF
NOTE: Be sure to maximize your Internet browser
so that no part of the presentation gets cut off.
MBA 6053, Economics for Managers

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Value of Auctions

oral auction

Second Price Auctions

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