Critique of Klemperers Auction Design Essay Example for Free

Critique of Klemperers Auction Design Essay What Really Matters in Auction Design, Paul Klemperer, Journal of Economic Perspective Volume 16, Number 1 Winter 2002, pp. 169-189 I really like this article because I agree with most of what it says. Auctions, in recent times, have become very popular and I dont need to interview anyone about this, I just need to examine myself to find out. Over the past few years, to be brutally honest, I have been absolutely addicted to eBay. com, an online shopping site made famous by the way in operates. Not only are all transactions made online, which is very convenient, but the way things are sold is what makes the shopping experience at eBay so unique, and fun. As the article mentions, auctions (like eBay) can be potentially good for both buyers and sellers. An auction can involve many buyers, for instance the auction of a house, whereas in the olden days, a negotiation over a house was usually between two people (bilateral negotiation) today there can be many sellers all competing for the same prize. This is good for the seller because now there is much more competition for the prize, therefore the seller will think hes getting the highest price for the same item. I think this is true because as human psychology goes, humans (generally speaking), tend to handle things better if they come in small increments, using the purchase of a house as an example, one would be somewhat overwhelmed at seeing a price tag of $1,000,000 for a house. However, instead of selling a house straight off a price-tag, if the auction method was taken, bidding might start at say $200,000, which sounds incredibly cheap. After that, the auction could rise in very small increments, say $3,000, which wouldnt be very over-whelming for the human mind to take in. And with this method, it is much easier to convince the human mind to believe that the house is worth $1,000,000, or more! However, as the article mentions, one should not be over-excited at the prospect of auctioning everything. Like most things, auctions can have their pit-falls. A major pitfall is bidder collusion. This is where buyers, or bidders, group together to cooperate with one another. This is a serious problem because this is regarded as anti-competitive behaviour which is a serious crime against the law. Sometimes, the ending winning price will be lower than what the seller had paid for it in the first place, making it an unprofitable auction. This could happen when for example, there are 10 Nike shoes for sale, and 10 bidders interested in Nike shoes. Collusion takes place when the 10 sly bidders come together and cooperate with each other so that each will go home with a pair of shoes at the lowest possible price, often the starting price of the auction, which often is very low. This is detrimental to the profits the seller was hoping to make because essentially, there is not enough competition, and it is very hard to prove in court that the bidders were colluding. I think this rarely on eBay, it hasnt happened to my knowledge, this could be because eBay has the power to monitor conversations between online members and any anti-competitive behaviour is detected and the members guilty will get into trouble, possibly kicked out and disallowed from using eBay again. A possible solution to this, as the article mentions is the tactic of hiding certain bits of information from the bidders. The use of the sealed-bid auction can be used so that bidders dont know what the current price/bid is and therefore they wont know what price they can and should collude at, because anyone can secretly enter a bid slightly higher than the collusion agreed price and walk away for more goods than everybody else. This is bad for that one person who deviated from the collusion and won everything if the other members find out it was him. However, another way to protect this competitive buyer is to make the winner anonymous. So now this seems like the perfect auction design, sealed bid auction, anonymous winner, but this design still has its pitfalls. Imagine you were the winner of the Nike shoes by sealed bid auction and you are anonymous, you paid $200 for them. However, later you find out that the runner-up bidder (the person with the second highest bid) only bided $50. It turns out that you bid and paid $150 more than you had to, this would be very humiliating and embarrassing for you. This can be a major problem I would imagine, however eBay has sort of managed to sort a similar problem out, you put the maximum your are willing to bid, if you win, you only have to pay $1 more than the runner up, that way you are the one willing to pay the most, yet you pay the least possible given the other competitors, this way, everyone stays happy. I think this is a really smart way to do it because not only can you almost assure yourself of winning, given youve got lots of money, but it means that youll pay as little as possible for the goods. The only other problem possible with this method is that the runner-up may become jealous of you and may bid up the price, these are called phoney bids, just so that youll have to pay more money, however, this is not often a problem because it is very risky for the runner-up to do this because he may over-take you in the bidding and end up having to pay the high-price. Which I would say serves him right for being so jealous and childish. If the runner-up wants the good so bad and is so jealous, let him have it but make him pay a high price. This brings me to the next thing which this article clearly points out, beware the Winners Curse. It is extremely easy to over-bid in any auctions because of the fact that bidders tend to think in terms of small increments and not big numbers (as pointed out above), therefore it is very easy for bidders to bid too much, win the good, and end up paying more than the goods actual value. In some instances, bidders are paying more for Nike shoes at auctions, when they could buy the same pair of shoes at a retail shop like say, Rebel Sports. This is called the winners curse, this can be avoided by getting as much information about the product/good as possible before bidding on the shoes. This I know has happened to me on numerous occasions on eBay. com. au, mainly because I wanted the product and I also felt proud about the fact that I beat everybody else at the auction, little did I know how much my confidence would plummet when I found out that I paid too much for the same pair of shoes! But, as Klemperer points out, hiding information about the product is not always at the sellers best interest. This point should be quite self-explanatory because, why would bidders bid aggressively if they dont know much about the item they are bidding on? This was also a lesson learnt the hard way for me, these days if Im bidding on something, I want to read that the item Im bidding is real/authentic and not a fake and that way if the item they give me is a fake, I can get a refund. If the seller wishes to encourage aggressive bidding, he/she has to provide useful and honest information for the bidders otherwise aggressive bidding is nothing but a dream. Another problem that can be faced by auctioneers is as Klemperer labels it Entry Deterrence and Predation, this is not a problem on eBay because all bidders bid at their own pace. However, in the case of an auction for say a house where bidders stand in a crowd with one another, really aggressive bidders tend to scare everyone away. On eBay where you can make small incremental bids as low as 20i at a time at anytime (provided the auction has not ended), with house auctions really aggressive bidders can bid huge increments which tends to scare off everybody else and so that person dominates the auction and has an advantage. This predatory action can be avoided by allowing the auction price to only rise by little increments at one time, this is sometimes seen where the auctioneers job is to offer the crowd a winning price from which the bidders only need to raise their hand to signal that they accept the price offered, this in turn removes a lot of the predatory actions of a few. There are many other interesting points made by Klemperer, he really is a scientist when it comes to auction analysis and I really admire the work he has done. So for you future bidders, watch out the winners curse and find out plenty of information about the thing you are bidding on, and dont get over-excited, this is very dangerous. Other than that, I look forward to reading more of Klemperers articles.