Lesson 8 of 14
The equilibrium price for a product can also be determined using an auction where potential buyers place competitive bids for the product and the winner is determined though a pre-specified mechanism. There are different types of auctions:
English Auction: An English auction is an ascending sequential bid auction. The bidders observe the bids of others and decide whether or not to increase the bid. The bid price keeps increasing as more buyers bid for a higher value. The item is sold to the person that first offers the highest bidder. In general, such auctions are called ascending price auctions.
First-price, Sealed Bid Auction: In this type of auction, all the bidders simultaneously submit bids on pieces of paper. The item is sold to the highest bidder. Each bid is sealed and bidders do not know the bids of other players.
Second-price, Sealed Bid Auction: In this type of auction, the same bidding process as a first price sealed bid auction is followed. The winder is the highest bidder. However, the high bidder pays the amount bid by the second highest bidder.
Dutch Auction: A Dutch auction is the descending price auction. The auctioneer begins with a high asking price. The bid amount decreases until one bidder is willing to pay the quoted price.
The auctions can be distinguished as common value auctions and private value auctions. In common value auctions, the true value of the item is the same for all bidders, for example, timber. In private value auctions, there is no true value of the item and each bidder puts the value for himself, for example, art and collectibles. Bidders know their own valuation of the item, but not other bidders’ valuations. Bidders’ valuations also do not depend on the bids of others.
In Dutch auctions, if there are many units for sale, each bidder will specify the price and the quantity he will accept at that price in the bid. At that price, the given quantity of the item will be sold to the bidder. The subsequent bids will be of lower price as price keeps descending. Sometime a modified Dutch auction process will be used, where all winning bidders will pay the same price.