Auction Types as Price Discovery Mechanisms Explained

Introduction to Auctions as Price Discovery Mechanisms

An auction is defined as an economic mechanism that involves the allocation of goods and the creation of prices for those goods through bidding. Through this process, bidders establish prices based on their individual valuations. Auctions are designed carefully to encourage bidders to express their true valuations for a product while discouraging collusion or cheating, in order to maximize revenues. According to McAfee (2017), an auction can be considered a method of price discovery — determining what an individual will pay for a product and who will ultimately receive it. Auctions have existed for a long period of time and take different forms depending on the specific goals of this economic mechanism. This paper examines different kinds of auctions as price discovery mechanisms and their use in different situations.

English, Dutch, Sealed-Bid, and Vickrey Auctions Compared

There are various kinds of auctions that are applicable in different situations as price discovery mechanisms. These different types differ in their strengths and weaknesses when identifying the real price or value of a product or item. The four most common types of auctions are English auctions, Dutch auctions, sealed-bid first price auctions, and Vickrey auctions.

English auctions and Dutch auctions are similar in that bids are public announcements. However, they differ in how the bidding is conducted for the valuation of an item. English auctions use an Open Ascending Price format in which the bid price increases until no further bids are placed. Once the highest bid has been established and no further bids are made, the highest bidder is declared the winner and pays his or her bid. By contrast, Dutch auctions — common in Europe — use a Descending Price format in which bidding starts at a price higher than the initial value of the product and decreases until a bidder makes a call. The first bidder to make that call is the winner and pays that price.

The sealed-bid first price auction differs from English and Dutch auctions in that bids are private information submitted simultaneously. The bidder writes his or her bid and submits it to the auctioneer, who opens all bids at once; the highest bid wins (McAfee, 2017). The Vickrey auction, also known as the sealed-bid second price auction, similarly involves private, simultaneous bids. However, while the highest bidder wins, that bidder pays only the second-highest price submitted — an important distinction that incentivizes truthful bidding.

References

Ausubel, L. (2001). Auctions for financial e-commerce. Federal Reserve Bank of New York.

Clarke, K. (2019, March 1). Luxury real-estate firm Concierge Auctions fights allegations of fraudulent bids. The Wall Street Journal.

Fine, L. R. (n.d.). Auctions. Library of Economics and Liberty.

McAfee, P. [Numberphile]. (2017, November 1). The ideal auction – Numberphile [Video file]. YouTube.

Roberts, J. W., & Sweeting, A. (2012, August 9). When should sellers use auctions? University of Maryland.