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A Special Type of Auction in the Trade War between the US and China

We’ve discussed several types of auction in class, from ascending-bid auctions and descending-bid auctions to sealed-bid auctions. Interestingly, there’s another type of auction that we haven’t discussed: a paradoxical auction known as the “dollar auction”, first coined by economist Martin Shubik. Here’s how this auction goes:


Imagine you have a dollar bill, $1.00. You have two bidders Bob and Jim. Here’s how the bidding works: After both bidders have decided on final bids, the winning bidder pays his value and gets the $1.00. However, the loser also has to pay the value he bid, but gets nothing in return. Say Bob is allowed to bid first. Bob, logically, will likely start out with the minimum bid allowed, say 1 cent. Then Jim, seeing how he can make a profit if he wins the auction with a bid of under a dollar, will bid 2 cents. Of course, Bob could bid 99 cents in which case Jim won’t be able to win the dollar without paying at least $1.00. But Bob wouldn’t stand to gain much from doing so, and if Jim decides to wipe the smirk off Bob’s face, then we’ll get the same result that follows. This process will escalate to the point where Bob is bidding 99 cents and Jim has a bid of 98 cents. Jim doesn’t want to lose out on 98 cents, so he’ll bid $1.00. Even if Jim doesn’t stand to gain anything, at least now he won’t lose anything. But then Bob will apply the same reasoning and bid $1.01. This process will keep escalating until someone decides to just take a loss.


Why do I explain this dollar auction? Well, because it’s relevant to what is going on in the news today, particularly with respect to the current trade war between the United States and China. In a trade war, as the author in the article argues, nobody wins. Initially, let’s say the United States has placed a small tariff on Chinese goods. The US should stand to gain from the tax levied on imported goods, but then China will retaliate with its own tariff. The US in turn, will place a higher tariff that will still be a net positive result. This back and forth process will continue until some point where additional tariffs can only hurt, analogous to the breaking point of $1.00. Say the US currently has the higher “bid”. If China stands by and doesn’t bid back, then China  will have effectively “lost” the trade war. So China bids back, and the back and forth process will continue until some country finally says enough is enough. But when that happens, both countries will have already reached the point where they are both hurt by tariffs, so even if someone technically “loses”, in reality both countries lose.


This is a perfect example that explains how game theory is extremely important in current events. Game theory is about human nature just as much as it is about rationality. While it may make sense to drop out of either the dollar bid or such a trade war when enough is enough, our emotions can push us to perform actions to achieve a feeling of victory that isn’t typically factored our payoffs. Sometimes, we may feel we benefitted at the hands of someone else suffering, even if our own worth doesn’t go up.


We can use game theory to analyze certain situations and then understand why something, such as tariffs, can either help or hurt us.



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