Networks

A second price auction is an auction in which the winner pays just slightly above the amount of the second highest bid, because that is the lowest price that would have won. This means that the dominant strategy for each bidder is to bid the highest price that they are willing to pay, or their true value for the item. Bidding less than this amount either does nothing, in the case that the bidder still wins the auction, or causes the bidder to lose an auction which he would rather have won.

One service that uses this type of auction is the popular site EBay, but for some reason this dominant strategy doesn’t always play out the was it should in theory. Often a rational buyer will bid his or her true value for an item, and never end up winning any of the items he or she desires. This isn’t because the buyer simply values the item below what others value it at, quite the contrary actually. The real reason that these bidders often lose, is because people like winning even more than they like the items they are bidding on. This leads buyers to drastically overbid on items that sometimes they could buy from a store for cheaper than their actual bid. This situation is an interesting occurrence of the phenomenon known as the winner’s curse.

The winner’s curse is when the winner overpays for the item they are buying. The winner may overpay or be “cursed” in one of two ways: 1) the winning bid exceeds the value of the auctioned asset such that the winner is worse off in absolute terms; or 2) the value of the asset is less than the bidder anticipated, so the bidder may still have a net gain but will be worse off than anticipated. However, an actual overpayment will generally occur only if the winner fails to account for the winner’s curse when bidding. (https://en.wikipedia.org/wiki/Winner%27s_curse)

In this particular scenario, it is hard to say whether the bidder that win’s is bidding over his true value or not. If asked, the bidder would probably say that he overpaid, but in the moment of bidding, the bidder decided he or she wants to win no matter the cost. This desire to win temporarily inflates the bidder’s true value for the item, but this new value will most likely deflate back to normal shortly after the auction ends, leaving the bidder feeling like he overpaid. Based on this evaluation, I think I will probably sell things on Ebay more often than I would buy them, to benefit from this effect.

http://people.hss.caltech.edu/~mshum/ec106/bajhortacsu.pdf