NBA Trades and Auction Theory
https://fansided.com/2019/08/01/nylon-calculus-nba-trades-auction-theory/
In class, we discussed the auction theory and the four different types of auction: ascending, descending, first-price, and second price. I read an article that discussed the two types of auction – first-price and second-price – and how the NBA (National Basketball Association) and the trading of players exemplify the auction theory. The main difference is whether the winner’s value or the second place’s value determines the amount paid. I was interested in this article, because I wanted the concepts learned in class to apply to an unexpected real-world setting.
The article begins by quoting Paul Klemperer’s summary of auction theory as “developing our understanding of…negotiations in which both the buyer and seller are actively involved in determining the price.” In the case of the NBA, the players are the sellers for themselves and the basketball teams, or recruiters, are the buyers in the auction.
First, the article speaks about the Anthony Davis trade where The Lakers paid the first-price value. Ultimately, it was realized that the second highest price was nowhere near what the highest price was, but The Lakers had offered the highest price – higher than what they actually wanted to pay for. Second, the article discusses an example where second-price auction had occurred in 2018 with Kemba Walker. Kemba Walker was almost offered to be part of Cavaliers’ All-Star point guard, as his “bid” but it was not brought into reality because the Cavaliers wanted to make sure LeBron James would return. Therefore, the Hornets were the “second-price” bidders. Because there was no other competition in the market, “the price could be driven down”. This is a case where the auction is controlled by the second-price’s value. Instead of looking at the player’s real value, the competition was based on beating the next highest bidder. Although this does not seem like an ideal second-price auction, this was reality for Kemba Walker and other players in the NBA.
Looking at these two scenarios in the basketball world, we can see that the seller (or the player) should prefer a first-price auction setting and the buyer (the recruiters) would prefer the second-price setting, as, in the case of less demand, the price can be easily driven down.
Note: the observation made by the article that sellers prefer a first-price auction neglects human behavior – bidders in first-price auction may bid lower than they would in a second price auction (as discussed in class).
Now, it’s also important to think about how to achieve optimal situations for buyers and sellers. In class, we discussed that in a second-price auction, the dominant strategy is your true value. Bidding lower than what the seller is willing to sell for, the buyer loses the ability to win at all. If the buyer bidded higher than the value that the seller is willing to accept, this does not improve the buyer’s payoff as the price to buy is greater than its true value. This means that it is best when there is less buyer. More bidders cause higher competition, provoking the buyer to bid higher than the other competing bids.
(Graph shows that buyer isn’t “winning”, because they have to pay greater than the truthful value)
In the seller’s perspective, it is better to have more buyers participate and begin at a price that is higher than what bidders would bid. Then, like a descending bid, they will decrease the value of offers until a team is willing to buy. This will produce a first-price auction, which is more favorable for sellers.
The article poses dangers of “bluffing” in both cases where sellers can pretend to have another bidder and wait until the buyer stops bidding to gain first-price value. Additionally, in a descending bid, a buyer may wait until the next highest bid and then suggest to beat that bid, which causes a second-price value out of a first-price auction. These are some loopholes/schemes in the system that may arise in any auctions. We can see that the auction theory is very complicated and there are benefits and disadvantages to each type of auction. This is also the reason why we see many complaints and many changes to the auction system in various industries, including Google.
Whenever there is a need for negotiation between two or more sides, the auction theory can be applied to the circumstance. I initially thought that athletics were so far-fetched from ideas from the academia. I realized other concepts in class can be applied to the real world.