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Information on Auctions


An auction is the process of buying and selling things by offering them up for bid, taking bids, and then selling the item to the highest bidder. In economic theory an auction is a method for determining the value of a commodity that has an undetermined or variable price. In some cases, there is a minimum or reserve price; if the bidding does not reach the minimum, there is no sale (but the person who puts the item up for auction still owes a fee to the auctioneer). In the context of auctions, a bid is an offered price.

Auctions are publicly seen in several contexts: in the antique, where besides being an opportunity for trade they also serve as social occasions and entertainment; in the sale of collectibles such as stamps, coins, classic cars, and fine art; in thoroughbred horseracing, where yearling horses are commonly auctioned off; and in legal contexts where forced auctions occur, as when one's farm or house is sold at auction on the courthouse steps.

Much more economically important, however, are auctions in which the bidders are businesses or corporations. Examples of this type of auction include:

  • spectrum auctions, in which companies purchase licenses to use portions of the electromagnetic spectrum for communications (for cell phone networks, for example.)
  • timber auctions, in which companies purchase licenses to log on government land.
  • electricity auctions, in which large-scale generators and consumers of electricity bid on generating contracts.
  • procurement auctions, in which companies submit bids on a government contract. In this situation the auction is reversed and the winner will be the company that submits the lowest bid to perform the work.

Internet auctions, dominated by the wildly successful eBay, have become very popular.

The world two largest auction houses are Christie's and Sotheby's. The world's largest online auction site is EBay.

Auction catalogs are frequently printed and distributed before auctions of rare and/or collectible items; these catalogs may be very elaborate works, with considerable details about the items being auctioned.

Types of Auctions

Some commonly used types of auctions are:

If more than one identical item is sold, there are two possible generalizations of the second-price auction. In a uniform-price auction, all of the winning bidders pay the price submitted by the highest non-winning bidder. Bidders will not typically bid their true value in a uniform-price auction with multiple units. In a Vickrey auction, the pricing rule is more complicated, but preserves the property that bidders will bid their true valuation.

Bidders in the traditional Dutch auction and sealed first-price auction will tend to underbid what they believe the item is truly worth in hopes of getting the item for less. This behavior is known as bid shading. These two auctions are also theoretically equivalent, but in practice Dutch auctions will produce less revenue than sealed first-price auctions (one of the important results of Experimental economics)

Work in the theory of auctions contributed to Vickrey's 1996 Nobel Prize in Economics

See Also

Auction catalog

An auction catalog is a catalog that lists items to be sold at an auction. Auction catalogs for rare and expensive items, such as art, jewelry, postage stamps, and antique furniture, are of interest in and of themselves, for they will frequently include detailed descriptions of the items, their provenance, historical significance, photographs, and so forth. In some cases, auction catalogs are key documentation for rare objects that are in private collections, and make up an important part of the libraries of students and dealers of the rarities.

Each entry typically includes a "lot number" identifying each item uniquely, a detailed textual description, and either an estimated price, or a "reserve" price below which the item will not be sold. Photographs may appear with the entry, or grouped into a separate section of the catalog; for mass-produced items like postage stamps, the textual description may be considered sufficient.

As a combined information source and "sales brochure", an auction catalog must tread a fine line between accuracy and promotion. For instance, any damages or flaws must be described exactly, so that buyers cannot be claim to have been deceived, but at the same time the description will typically include words playing down the bad points (as in "brownish spot that does not detract from appearance" or "faint crease, as is common"). Similarly, special characteristics are also called out, such as "one of only four known examples of this type", or perhaps a photograph of an item of jewelry being worn by a famous person.

Auction catalogs may be sent gratis to favored customers, but the better catalogs will cost, sometimes as much or more than a regular book. These kinds of catalogs may in turn be sold by bookstores, or even appear as items in book auctions.

Some time after the auction is concluded, recipients of the auction catalogs will receive a "prices realized" document, a bare listing of the lot numbers and the prices for which each was sold.

Online auction business model

The online auction business model is one in which participants bid for products and services over the internet.

When one thinks of online auctions they typically think of E-Bay, the largest online auction site. Like most auction companies, eBay does not actually sell goods that it owns itself. It merely facilitates the process of listing and displaying goods, bidding on items, and paying for them. It acts as a marketplace for individuals and businesses that use the site to auction off goods and services.

Several types of online auctions are possible. In an English auction the initial price starts low and is bid up by successive bidders. In a Dutch auction the price starts high and is reduced until someone buys the item. Ebay also offers fixed price listings.

Strengths of the business model

The strategic advantages of this business model are:

1) No time constraints. Bids can be placed at any time, 24 / 7 . Items are listed for between 1 to 10 days (at the discretion of the seller), giving purchasers time to search, decide, and bid. This convenience increases the number of bidders.

2) No geographical constraints. Sellers and bidders can participate from anywhere that has internet access. This makes them more accessible and reduces the cost of “attending” an auction. This increases the number of listed items (ie.: number of sellers) and the number of bids for each item (ie.: number of bidders). The items do not need to be shipped to a central location, reducing costs, and reducing the seller’s minimum acceptable price.

3) Intensity of social interactions. The social interactions involved in the bidding process are very similar to gambling. The bidders wait in anticipation hoping they will “win” (eBay calls the successful bidder the “winner”). Much like gambling addiction, many bidders bid primarily to “play the game” rather than to obtain products or services. This creates a highly loyal customer segment for eBay.

4) Large number of bidders. Because of the potential for a relatively low price, the broad scope of products and services available, the ease of access, and the social benefits of the auction process, there are a large numbers of bidders.

5) Large number of sellers. Because of the large number of bidders, the potential for a relatively high price, reduced selling costs, and ease of access, there are a large number of sellers.

6) Network economies. The large number of bidders will encourage more sellers, which, in turn, will encourage more bidders, which will encourage more sellers, etc., in a virtuous spiral. The more the spiral operates, the larger the system becomes, and the more valuable the business model becomes for all participants.

7) Captures consumers’ surplus. Auctions are a form of first degree price discrimination. As such, they attempt to convert part of the consumers’ surplus (defined as the area above the market price line but below the firm’s demand curve) into producers’ surplus. On-line auctions are efficient enough forms of price discrimination that they are able to do this.

Companies that use the model

See Also:

Finding related topics


In economics, arbitrage is the practice of taking advantage of a state of imbalance between two (or possibly more) markets: a combination of matching deals are struck that exploit the imbalance, the profit being the difference between the market prices. A person who engages in arbitrage is called an arbitrageur.

For example, if you can buy items at one price at a factory outlet and sell them for a higher price on an internet auction website such as eBay, you can exploit the imbalance between those two markets for those items. The term "arbitrage", however, is usually applied only to trading in money and investment instruments (such as stocks, bonds, and other securities), not to goods, and the difference in prices is usually referred to as "the spread", so arbitrage is often defined as "playing the spread" in the money market.

Arbitrage has the effect of causing prices in different markets to converge. As a result of arbitrage, the currency exchange rates, the price of commodities, and the price of securities in different markets all tend to converge to a fixed price. The speed at which the prices converge is one measure of the efficiency of a market.


Here's a theoretical example: Suppose that the exchange rates (after taking out the fees for making the exchange) in London are £5 = $10 = ¥1000 and the exchange rates in Tokyo are ¥1000 = £6 = $10. Converting $10 to £6 in Tokyo and converting that £6 into $12 in London, for a profit of $2, would be arbitrage.

One real-life example of arbitrage involves the stock market in New York and the futures market in Chicago. When the price of a stock in New York and its corresponding future in Chicago are out of sync, one can buy the less expensive one and sell the more expensive. Because the differences between the prices are likely to be small (and not to last very long), this can only be done profitably with computers examining a large number of prices and automatically exercising a trade when the prices are far enough out of balance. The activity of other arbitrageurs can make this risky. Those with the fastest computers and the smartest mathematicians take advantage of series of small differentials that would not be profitable if taken individually.


Arbitrage is subject to a number of risks which become magnified when leverage or borrowed money is used. It can be problematic if prices shift adversely during the execution of trades. Another risk occurs if the items being bought and sold are not identical and the arbitrage is conducted under the assumption that the prices of the items are correlated or predictable.

Long-Term Capital Management (LTCM) lost $100 billion mis-managing this concept in September 1998. LTCM had attempted to make money on the difference between different bond instruments. For example, it would buy U.S treasury bonds and sell Italian bond futures. The concept was that because Italian bond futures had a less liquid market, in the short term Italian bond futures would have a higher return than U.S. bonds, but in the long term, the prices would converge. Because the difference was small, large amount of money had to be borrowed to make the buying and selling profitable.

The downfall in this system began on August 17, 1998, when Russia defaulted on its rouble debt and domestic dollar debt. Since the markets were already nervous due to the Asian crisis, investors began selling non-U.S. treasury debt and buying U.S. treasuries, which were considered a safe investment. As a result the return on U.S. treasuries began decreasing because there were many buyers, and the return on other bonds began to increase because there were many sellers. This caused the difference between the returns of U.S. treasuries and other bonds to increase, rather than to decrease as LTCM was expecting. Eventually this caused LTCM to fold, and a bailout had to be arranged to prevent a collapse in confidence in the economic system.

An ironic footnote is that they were right long-term (the LT in LTCM), and a few months after they folded their portfolio became very profitable. However the long-term does not matter if you cannot survive the short-term, and that they failed to do.

This page created and maintained by Jamie Sanderson.
© Jamie Sanderson 1999-2005.