Table of Contents
Introduction 2
Key concepts 3
English auction 3
Dutch auction 3
Sealed bid first-price auction 3
Sealed bid second-price auction 3
Values 3
Independent private 3
Pure common 3
Affiliated model 3
The market for used cars 4
Revenue Equivalence Theorem 5
Risk aversion 5
Affiliation and common components 5
The winners curse 6
Reserve prices 6
Number of bidders 6
Conclusion 7
Appendix A: Entry restrictions 8
References 9
Introduction
This report seeks to analyse the application of auction theory principles to the design of sales of used cars. The concept of the Revenue Equivalence Theorem (RET) will be explored to determine how profit maximisation can be achieved by sellers of used cars.
In their most simple form, auctions are allocative mechanisms often most beneficial in situations where the value of items is unknown, can vary and/or does not have a determinable market value (Feldman & Mehra, 1993). This report will first address key concepts to distinguish aspects by which auctions can be classified, before going on to explore how conditions within used car auction design can maximise profitability, and concluding with findings, limitations and developments of the research.
Key concepts
The four primary types of auction are classified by their differing rules, and consequential bidding strategies of bidders. The general principles of each design are briefly discussed below.
English auction
Arguably the most prevalent form, the English auction is also referred to as an ascending auction. The sale of goods using this mechanism is conducted in real time, with bidders making successively higher bids, usually in small increments. The item is won by the highest bidder, who will pay the highest bid.
Dutch auction
The Dutch auction, used less frequently in practice, is often referred to as a descending auction. Similarly to English auctions, the bidding takes place in real time and is observed by all. Auctioneers begin at a high price, which is gradually lowered until a bidder indicates interest. The item is sold to the winning bidder at the highest bid.
Sealed bid first-price auction
Unlike English and Dutch auction designs, sealed bid formats are unobserved by others- resulting in imperfect information- and cannot be adjusted. The bidder with the highest bid pays their price and wins the item.
Sealed bid second-price auction
Second-price auctions follow the same principles as sealed bid first-price auctions, but instead allows the highest bidder to win the item while paying the second highest price.
Values
A key feature of auctions is the presence of uncertain and asymmetric information. The strategies of bidders are determined by the values placed on the item in question, which can be categorised by independent private values and pure common values.
Independent private
The independent-private model refers to the valuations individuals place on items according to individual preferences. These values are independent of other’s valu...
