The Winner’s Curse
https://mises.org/library/winners-curse
In an auction in which you are bidding on something with the purpose of reselling that item, your goal is to make profit. In other words, you aim to make a bid that is less than what you deem the item is worth or will sell for and win in the auction. If you are involved in an auction in which all people have this mentality, you can assume that all people will place their bid lower than what they deem the true price of the item is at. Since people bid different values depending on what they believe the true value of the object is, this means that the person who assigns the item the highest value will win the bid. If this winner’s true value for the item is more than the actual value of the item, the winner will lose money. This phenomena is “the winner’s curse.” Since bidders wish to avoid this circumstance, it often causes them to lower their bids even more.
I read an article called “The Winner’s Curse?,” in which the author questions this reasoning with counter examples and decided that definition of the winner’s curse rests on two assumptions. The first assumption is that all people have the same value for an item (they all believe that the item has a true value at which it can be sold and receive maximum profit). This example does not hold in the case of people bidding on items for sentimental reasons. The second assumption is that all people can receive the same value from an item. For example, he explains that when oil companies bid on land for oil, some companies may value the land more simply because they can extract more oil from the land due to having more efficient methods.
I found this topic interesting because it connects the bidders to one another. People lower their bids because they want to make profit and want to avoid the winner’s curse. However, at the same time, they are aware of their other bidders. They assume that their other bidders are conscious of this phenomena and thus also lower their bid. Of course, other information may impact whether or not the bidders think that their co-bidders are thinking in the same way as them, this adds more layers to the thinking.