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Bidder Psychology In Ascending-Bid Auctions

Auctions, as defined in our textbook, are helpful when the seller knows neither how much to value an object himself, nor how much potential buyers value it. In Professor Easley’s lecture, we briefly focused on the four basic types of auctions when the seller is auctioning off one item: ascending-bid auctions (or English auctions), descending-bid auctions (Dutch auctions), first-priced sealed-bid auctions, and second-price sealed-bid auctions.

In descending-bid auctions, the price starts off high, and is gradually decreased by the seller until the bidder with the highest maximum bid steps up and offers to buy the item—the price for the item is the highest max bid of all the bidders. And although the process is different, the same is said for first-priced sealed-bid auctions: if everyone were to put down the maximum amount they were willing to pay, then the winner is the one who is willing to pay the most, and will pay that amount to get the item.

In ascending-bid auctions, bidders continue to increase the price until there is only one bidder left willing to pay the price for the item—this price is essentially the price at which the second-to-last bidder drops out. This should essentially be the same as a second-price sealed-bid auction. If all bidders were to place the max they were willing to pay for the item, then what the winner needs to pay is dependent on the next runner up’s maximum bid. This is essentially the dropout minimum for the second highest bidder, as it is assumed that the second highest bidder is not willing to pay any bit more than his/her max bid.

This is all very logically and economically sound—why on earth would anyone pay for more than their perceived utility for any such object? But as Seth Godin reveals in his blog, people don’t exactly behave rationally in auctions. He briefly mentions the max bid system that eBay uses, which is essentially a second-price sealed-bid because the user can put in the max amount he/she is ever willing to pay for an auction item, and the eBay system will automatically outbid an opponent by increasing the max bid by the minimum increment until the bid price is past the user’s max.

And then declares that people who actually win auctions do not use this feature.

Instead, they resort to an ascending-bid auction method that eBay has implemented along side the second-price sealed-bid method (which is a pretty interesting idea). Theoretically, these two types of auctions are the same thing. However, what makes ascending-bid auction so much more powerful is the user psychology that affects bidders.

When someone places a bid, he, in essence, believes the item is already his. Thus, when someone outbids him, rather than thinking of the second bidder as someone who also wants the seller’s item, the original bidder is more prone to thinking that the second bidder has stolen the possession of that item away from him. This intrinsic feeling of ownership that results in placing a bid on an item causes serious bidders to become emotionally rooted—they are offended by those who out-bid them, and they furiously seek to claim what they have already identified as theirs. Pride (to win and to not back out), also comes in to play, especially because bidder history is made very transparent and public on online auction sites like eBay. Winning is a big deal, and losing is shameful.

Because bids usually increase by small increments towards the end of bidding wars, bidders can easily justify increasing their bid just a little bit more, in hopes of winning the auction. This is also dangerous because these small, seemingly harmless increments add up quickly, until the bidder runs the danger of winning the auction, but at a price that’s many times the actual max bid they were willing to give. Auction-buyer’s remorse is a term that incorporates this feeling of regret once the bidder has awaken from the heated bidding war, to realize that he really didn’t want that item all the much (a thousand dollars for a $20 piece of furniture? Really?).

It’s clear to see that bidder psychology in auctions plays a huge part of what make auctions so appealing for the sellers. Though what we have learned in class is very important fundamental knowledge about how auctions should work, ignoring the psychology behind auctions will result in an incomplete evaluation. Bidder psychology is equally as important because it is faulty to assume everyone will always play the game the way a rational economist would. As Seth says, “in many auctions, the most irrational person wins.”

Source: http://sethgodin.typepad.com/seths_blog/2007/05/thinking_about__1.html

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