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Penny Auctions

http://faculty.haas.berkeley.edu/ned/Augenblick_JMP_Penny_Auction.pdf

Penny auction websites are a relatively recent development in the online business world. There are numerous sites that run these penny auctions. In general, a penny auction is run by starting the bidding at $0.00 for a high price item like a television, iPad, or Kindle. Bidding starts by placing a bid that is a certain increment higher than the current bid. In most cases, this bid increment is a penny. Every time a user bids, they have to pay a fee to the seller. For each new bid, there is a timer that counts down to the end of the auction. The user who has the latest bid by the time the timer runs out wins. However, at any time, the auction can continue as long as one more person bids the bid increment. This starts the process over, and the user will have to bid again to stay in the auction. This article examines how the bidders and sellers behave in a penny auction. The study of popular penny auction sites and its bidders revealed many interesting results. For one, the study found that bidding behavior could be explained by the “sunk cost theory”, a theory economists recognize as illogical.  This phenomenon appears in penny auctions every time a new bid is made to increase the timer. Every time the length of the auction increases, the more a previous bidder becomes invested in it. Even though their chances of winning the bidding do not depend at all on their previous bids, people will often continue bidding after they have already “sunk” so much time and money into it, because they want to see some reward for their efforts. For this reason, penny auctions are extremely profitable for sellers, because it only takes one user to extend the bidding, opening it up for many more additional bids and the extra fees that come with it.

Penny auctions relate to the discussion of auctions in class. They are a form of the English ascending bid, where the bidders make open bids against others and the highest bidder wins. Penny auctions often have the sunk cost fallacy occurring, because to users it is frustrating to have been bidding on an item for a long time, only to have a new bidder enter with a few seconds left on the timer to extend the bidding again. After all, what is a little bit more for an item when the retail price is so much higher?  For this reason, the seller will often make very high profits if most of its users think the same way and keep bidding and paying a small fee each time they bid again.  Since the prices are so low, and usually just increase by a penny for each bid, the seller has an extremely low price for the item that makes their item very valuable and attracts many buyers. However, there are some problems for sellers. One such problem for sellers is that users figured out a strategy to winning penny auctions – the fewer users an auction has, the better the chance of winning, because it’s less likely someone else will bid to extend the auction. Sellers need to adjust,  possibly by hosting less auctions to increase the number of bidders for each. However, with the Internet and a simple business model, it is easy to open up a penny auction site, and users may leave to go to less populated ones. Penny auctions are a unique type of auction, and often lead to high profits for sellers, while users may keep bidding past what their true value for it was, because of the idea that they have already bidded so much already, and they do not want to see that effort go to waste.

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