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Y3 Micro > Lecture 9- Auction Theory > Flashcards

Lecture 9- Auction Theory Flashcards

1
Q

Is the surplus gained from an auction profit?

A

No it is rent (ie unearned income)

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2
Q

In all markets, prices adjust to form what?

A

equilibrium

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3
Q

Who are equilibrium prices formed by? What does this make the equilibrium called?

A

Walrasian Auctioneer, making it a Walrasian Equilibrium

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4
Q

What happens in Theoretical Auctions?

A

Equilibrium is attained via tâtonnement (“Groping” or “trail & error”), where theoretical prices are “called out” until supply and demand balance.

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5
Q

Practically, what are auctions a mechanism for?

A

Price formation

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6
Q

Why is auction theory so useful?

A

As it helps economists to understand strategic behaviour in the presence of asymmetric information.

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7
Q

What does the value/valuation mean?

A
  • Value to bidders/seller
  • Maximum willingness to pay
  • Minimum selling price
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8
Q

What is a bid?

A

This an expression of a willingness to pay, but not necessarily the maximum you will pay

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9
Q

What is a bid increment?

A

The amount a bid changes by (if successive bidding occurs)

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10
Q

Define price.

A

The amount paid by the “winning” bidder

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11
Q

Define rent

A

The difference between the valuation and the price.

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12
Q

What does information determine?

A

Information determines bidding behaviour and outcomes.

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13
Q

Give 3 examples of uncertain/asymmetric information in an auction market:

A
  • Sellers have uncertain information about bidders’ valuations
  • Bidders have uncertain information about each other’s valuations
  • Sellers/bidders may have different ‘information’
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14
Q

What else does information have an impact on?

A
  • Affects Relationships
  • Interdependence in Decision-making
  • Strategic Behaviour
  • Rules of the Auction
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15
Q

What are the Economic Mechanisms?

A

The “Rules of the Game”

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16
Q

Are auctions oligopolistic?

A

No, they’re monopolistic, you can only sell something if you own all the power over it.

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17
Q

Who determines the rules of the game?

A

The seller, as they are the ones endowed with the item

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18
Q

What kind of rules may a seller decide on? Why may they change these?

A
  • How bids are communicated;
  • Setting a reserve (ie minimum price)
  • How the winning bid is determined
  • The seller will likely choose rules in line their objectives
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19
Q

What are tenders?

A

Tenders are a “reverse” auction involving a monopsony buyer. Examples often include tenders for construction contracts, and deliberately high bidding often occurs

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20
Q

What are the types of auctions classified by?

A
  • Their rules
  • Their incentive structures
  • Their information structures
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21
Q

List 2 possible objectives of a seller.

A
  • Profit Maximisation
  • To promote competition (often the case with government contracts)
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22
Q

What makes an auction Pareto Efficient? Is it the price?

A

When the item is sold to the bidder with the highest valuation, the price paid is irrelevant.

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23
Q

How many standard kinds of auctions are there?

A

4

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24
Q

What are the 4 kinds of auction?

A
  • English Auction
  • Dutch Auction
  • Sealed Bid Auction
  • Vickrey Auction
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25
Q

Which kind of auction is the most common, why?

A

The English Auction is the most common, and likely because it is the most simple.

26
Q

Describe the English Auction

A
  • Ascending Bids
  • Bidders make successively higher bids
  • Observed by all
  • Highest bidder wins (above any reserve)
  • Price Paid = The Highest Bid
27
Q

What kind of things usually use a Dutch auction?

A

Things that tend to deteriorate, such as fresh fish.

28
Q

Describe a Dutch Auction.

A
  • Descending Bids
  • The auctioneer begins with a high bid, which is lowered gradually
  • Observed by all
  • Winner is the first person to call out
  • Highest bidder wins
  • Price paid = the highest bid
29
Q

Which market has operated on a sealed bid system for over 100 years?

A

The Scottish Housing Market

30
Q

Describe the Sealed Bid system.

A
  • Bidders write down their bids
  • Unobserved by others
  • Highest bidder wins
  • Price paid = the highest bid
  • First Price Sealed Bid
31
Q

What is the Vickrey Auction sometimes called?

A

The Second Price Sealed Bid

32
Q

Describe the Vickrey Auction

A
  • Bidders write down their bids
  • Unobserved by others
  • Highest bidder wins
  • Price paid = Second Highest Bid
33
Q

List the 3 main valuation schemes:

A
  • Independent Private Values
  • Pure Common Values
  • Affiliated Values
34
Q

Describe what Independent Private Values are

A
  • Individual Valuations (vi)
  • Based on Individual Preferences (hence private)
  • Bidders know their own private value but are unaware of other bidders’ valuations with certainty
  • Individual valuation does not change even if other bidders’ valuations known
    (hence independent)
35
Q

Give an example of a good that may derive its valuation from “Pure Common Values”

A

Gold

36
Q

Describe the Pure Common Values valuation method:

A
  • An item has the same intrinsic value for everyone (v)
  • Bidders have different estimates of the common value (si)
  • Based on private information
  • A bidder’s estimate is likely to change if estimates of other bidders were known
37
Q

What is true about the Affiliated Values valuation method?

A
  • It contains elements of both the Independent Private Values and the Pure Common Values models
  • Bidders’ valuations are positively correlated
38
Q

What is the “Winners Curse” of a common value auction?

A

If you have won, you have probably overpaid.

39
Q

What do Private Value auctions assume about the bidders?

A
  • Risk Neutral
  • Instrumentally Rational
  • Maximise Expected Rent
  • Do not know each others valuations
  • Know the number of bidders (N)
  • Know the probability distribution from which valuations are drawn
40
Q

What belief would bidders participating in Independent Private Value valuation have about the distribution of values?

A
  • Individuals’ valuations are unrelated
  • Knowledge of other valuations would not affect any individual’s valuation
  • A typical assumption about distribution of private values (not a necessary assumption) is uniformity
  • All potential bidders would have this belief about the distribution of values
41
Q

What do we mean when we say a typical assumption about distribution of private values (not a necessary assumption) is uniformity?

A

i.e that they are nicely placed for the distribution

42
Q

What are assumptions and the optimal/dominant bidding strategy (irrespective of other bidders) in an English Auction?

A
  • Assumption of very small bid increments
  • Continue to raise bid as long as bidding below vi
  • Withdraw when bidding ≥ vi
  • Bidding above private value produces a loss
43
Q

In an English auction, if the bid is successful, what do we call the price? What about the rent? What about the price paid? What does this assume?

A
  • Price = bi
  • Rent = vi-bi
  • Price paid = second highest private value, v2 (+bid increment)
  • This assumes all other bidders are following the same strategy
44
Q

What is the optimal/dominant bidding strategy in a Dutch Auction?

A

Call out (bid) when the price falls below private valuation, however by how much depends on calculating with reference to the number of bidders (N)

45
Q

What is the calculation with reference to the number of bidders in a Dutch Auction?

A

[(N-1)/N] * vi

46
Q

Why in a Dutch Auction can the best strategy only be an estimate?

A

As the distribution of bids may not be even, for example auction fever

47
Q

What is the optimal/dominant bidding strategy in a First Price Sealed Auction?

A
  • A ‘one shot’ game
  • Strategy: submit a bid below private value (but what is this distance?)
  • We need to consider other bidders and their strategies
  • The optimal bid is the bid which maximises expected surplus
48
Q

What is the trade off in the maximisation of expected surplus in a First Price Sealed auction?

A
  • A lower bid increases potential rent (vi – bi)
  • But a lower bid reduces the probability of a successful bid
49
Q

What do the chances of a successful bid p(b) in a First Price Sealed auction increase with?

A
  • Increases with bi ;
  • Decreases as N (No. of bidders) increases
50
Q

So in a First Price Sealed auction, what is true about the optimal distance below vi to bid?

A
  • Depends on bidder’s beliefs about strategies and valuations of rival bidders, embodied in p(b)
  • There is a situation of interdependence where each bidder must have an assessment of p(b), based on conjecturing a relationship between rivals’ valuations and their bidding behaviour
51
Q

Which 2 types of auctions have the same optimal bidding strategy? What is this?

A

Dutch and First Price Sealed
bi = [(N-1)/N] * vi

52
Q

So lets say you are in a Dutch Auction or a First Price Sealed auction, and there are 2 bidders, what should you bid? What happens if the number of bidders increases?

A

[(2-1)/2] *vi,
So half of your private value, and when bidders increase, your bid relative to your private value increases, so if there are 3 bidders it will be 2/3 of private value etc. When N tends to infinity, the optimal bid tends closer to vi

53
Q

Why are the best strategies the same in First Price Sealed and Dutch auctions?

A
  • Because information structure for bidders is the same
  • Strategy depends on p(b)
  • A weaker form of equilibrium than dominant strategy equilibrium
  • “Best” bidding given (correct) assumptions about rivals
54
Q

Why would estate agents switch from selling houses via an English auction to a First Price Sealed?

A

As due to the weaker equilibrium, it isn’t necessary to have mass amounts of bidders

55
Q

Give some shared characteristic about Dutch and First Priced Sealed auctions. do they achieve Pareto efficiency?

A
  • These formats do not demonstrate incentive compatibility due to the incentive to bid below private value and how much below depends on the probability of success assumed by each bidder p(b)
  • They may achieve Pareto efficiency but bidders’ beliefs must be correct beliefs and Pareto efficiency is not guaranteed
56
Q

What is the dominant strategy in a Vickrey Auction, regardless of other bids?

A

bi = vi
Submit a bid equal to private value

57
Q

Why are Vickrey auctions often used?

A

To gather information on customers

58
Q

Why would you never bid above your private value in a Vickrey auction?

A

Because it either will not make a difference, or somebody else has a bid higher than your valuation, thus making you pay over your valuation, there is no way to gain from it.

59
Q

Why would you never bid below your private value in a Vickrey auction?

A

Because you may not win the auction, as you have bid too low.

60
Q

Give some shared characteristic about English and Vickrey auctions. do they achieve Pareto efficiency?

A
  • The bidder with highest private value wins -assuming bidders playing optimal bidding strategies
  • Price paid equals second highest value and is not profit-maximising for seller but as number of bidders increases, difference between v2 and v1 decreases
  • They are both Pareto efficient
61
Q

What are the incentive of bidders in English and Vickrey auctions?

A

To reveal their true preferences (ie bid up to private value). These bidding strategies are dominant strategies, and are irrespective of other bidders’ strategies.

Y3 Micro (11 decks)

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