A Flower or a Mansion? Status Symbols and Market Bubbles Explained by Dutch Auctions.
According to this article from Investopedia, during the 17th century, tulip bulbs were selling at a price roughly equal to mansions in Amsterdam. Having tulips in one’s garden was a sign of wealth and good taste. The phenomenon started due to the flower’s scarcity in Europe, but as Holland’s elite began buying tulips to display in their garden, the middle class also sought tulips to seemingly level themselves with the wealthiest families in the country. With both the upper and middle classes in the market for tulips, prices rose, further increasing the value of owning tulip bulbs, not just for resale value, but also because of the massive amounts of disposable income one must have to spend so much money on flowers.
When a good is so overvalued, one strategy for sellers to make the most money is to hold an auction. Because there is no natural way to evaluate the value of a tulip bulb given that it is solely ornamental in purpose, sellers trying to gauge the market price could very likely underprice the bulbs. Further, because the value of tulips was largely determined by how exclusive the market is (meaning prices have to be high enough so that only the wealthiest people could afford the flowers), selling at a price lower than the market value would not only result in sellers losing some of their share of the total valuation, it could also devalue the bulbs, leading to lower prices in the future. That is, because tulips were worth an irrationally large amount, a seller might have a difficult time determining the line between ridiculous prices and prices high enough to maintain exclusivity.
As we discussed in class, when a seller does not know people’s values for an item, an auction allows customers to reveal their preferences. A dutch auction, which starts at some arbitrarily high price and decreases until a buyer is willing to accept the price, maximizes the possible market-clearing prices, resulting in sellers earning a larger share of the total valuation.
For framing reasons, starting at a very high asking price can prime customers to higher prices, further causing overvaluation. This pattern is not exclusive to the 17th-century plant market; many luxury brands and art retailers today rely on similar types of luxury markets to maintain high prices.
Source: https://www.investopedia.com/terms/d/dutch_tulip_bulb_market_bubble.asp