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Auctions Vs. Fixed Prices Sales on eBay

http://www.businessweek.com/technology/content/jun2008/tc2008062_112762.htm

eBay used to make most of its money off of online auctions. Recently however, eBay has seen decreases in its auction profits, while companies like Amazon have grown rapidly off of the success of fixed price sales. In an effort to keep up with other companies, “eBay has significantly de-emphasized dynamic-priced items in favor of fixed-price listings.” This decrease in popularity of online auctions is most likely due to the the fact that people value their time more than they value the slight savings from an auction. Initially people were excited by auctions, where they essentially were playing a game against other bidders. Eventually though, people grew tired of this and preferred the ease and quickness of fixed-price purchases.

This topic can be related to the preferred seller concept discussed in class. The sellers can be broken into two groups, one group of auction sellers and one group of fixed-price sellers. Initially, the payoff of winning an item in an auction was (value)-(bid)-(time)+(win); this means that the winner’s payoff is their value of the item minus what they paid for it, minus the value of the time spent competing in the auction, plus the value of winning the auction (it feels good to win). To find the preferred seller you can compare this to the payoff of buying an item at a fixed-price, which is just your value of the item minus what you paid for it. Due to the nature of online auctions, the price paid in an auction will be less than or equal to the fixed-price. When you compare the expected payoffs of auctions and fixed-price purchases, you get the equation v1-b1-t+w =?= v1 – f1. Where v1 is the buyers value of the item, b1 is the winning auction bid, t is the value of the time spent competing on the auction, w is the value of winning the auction, and f1 is the fixed-price. Given that b1 <= f1, if the value of winning the auction is greater than the value of the time spent competing in the auction, the expected payoff of winning an item in an auction is greater than the payoff of buying the item at a fixed price. Therefore, the preferred seller is the auction seller.

Now, the thrill of winning an auction has worn off, so the payoff for buying from an auction is v1-b1-t. The payoff for buying the same item at a fixed-price is v1-f1. You can still assume that b1 <= f1. Now if you compare the payoffs of an auction vs. a fixed-price you get the equation v1-b1-t =?= v1-f1. From this equation you can see that if t >b1-f1, the fixed-price seller will be the preferred seller.

This explains why online auctions have become less popular while fixed-price sales have become more popular. As buyers become less enamored with winning an auction, their payoffs for winning become less as the variable w decreases, while the payoff from the fixed-price sale will stay the same. Eventually the payoff from winning an auction will move from greater than the payoff from buying at a fixed-price to less than the payoff for buying at a fixed price. When this happens consumers’ preferred seller will switch from auction sellers to fixed-price sellers; so more and more consumers will buy at fixed-prices.

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