Auctions are a form of trade, a mechanism to match a buyer and seller for any item of value. The valuation of items is usually subjective and is usually achieved through a bidding process that finally ends after the last bid is accepted by the seller. Historical evidence suggests that auctions have been around for about 10,000 years. Auctions have been used to sell items to consumers, auction off assets such as treasury bonds and transmission bandwidths, and for many other types of sales. An auction market is a place for off-line auctions or a virtual space for online auctions that facilitates auctions. The main function of a good auction market is to facilitate an efficient and fair trade. Efficiency could be defined as generating the best valuation for the seller with the least cost of the auction process itself. Fairness could be defined as eliminating any advantage to buyer(s) or seller(s) that could be derived through a variety of unethical, illegal, and other means. Over the long history of auction markets, many different auction mechanisms have been designed to increase efficiency and fairness.
Different types of auction markets (or mechanisms) and efficiency and fairness issues related to those are presented next. The number of identical items for sale, number of sellers, and number of buyers are the factors that are relevant in designing appropriate auction markets. For example, if all the items being sold are one-of-a-kind items, and the auction has multiple buyers and one seller, we will have a traditional English auction. Here, each bidder would successfully bid higher and the final price is settled once there are no more bids. If the seller has several of the same items the auction would be a Dutch auction, where the bidders will still continue to bid higher and higher. However, in this auction, the bidders will have the choice of indicating the number of items they are committed to buy at their price. If there are many sellers and a single buyer the auction results in a reverse auction. For example, a state government interested in buying aluminum sheet could invite several sellers to the auction, the sellers bid against each other by continually lowering their sales price and the final price is reached when there are no more bidders at a lower price. Auctions can also be open bid, where everyone in the market knows the value of the bids of other participants, or closed bid, where the bids are not disclosed.
Auctions can also be classified based on the type of participants as consumer to consumer, business to consumer, government to business, and so on. Auctions can also be classified as off-line or online. In an off-line auction, the most common auction before the explosive growth of the Internet, all potential buyers and the seller(s) would congregate in one location (a physical place), the buyers would examine the items being auctioned off and develop an initial valuation for the item, and then start bidding for the item at a preset time and continue to bid until there are no more bids. In contrast, online auctions are held in a virtual space on the Internet and buyers and sellers can be anywhere in the world. An example of the most successful online Internet auction market is eBay. If a participant is purchasing an item in an auction to derive some personal value, such as buying a bottle of 100-year-old wine to consume at a special occasion, then the value of the item is considered a private value. However, if all the buyers perceive the same use for the item, like buying a certain transmission bandwidth for developing cell phone networks in a certain location, the value generated will be common value.
In any auction market the efficiency increases as more buyers and sellers participate as there will be more competition. Efficiency also increases when there is information transparency, that is, all participants have access to all the information necessary to assess the value of the items. In an open-bid auction, the information generated through the bidding process increases the efficiency. This transparency is lacking in the sealedbid process. A variation of the sealed-bid auction is a multiple-stage process, where the bid details of each stage are revealed to all participants to improve the efficiency of the bidding process in successive stages. In eBay auctions, where there is a preset time for the closing of the auction, it is possible for the bidder with the most information about the item to wait until the last minute to start bidding. This reduces the information available to other bidders in the bidding process and leads to information asymmetry and a reduction in the efficiency of the auction market. This last-minute bidding, to obtain a valuable item for a cheaper price, is sometimes known as sniping. Auctions on Amazon.com compensate for this by not having a firm preset close for an auction. These auctions close only when there are no bids for a 10-minute period after the last bid before the flexible preset close time. This reduces the possibility for sniping and provides more valuation information to all participants. In some auctions, sellers may bid in their own auctions early in the bidding process to provide wrong information about the value of the items to other bidders thus potentially increasing the value of the final bid. This is called shilling.
Some auction markets, both off-line and online, try to eliminate this unfair practice by requiring the participants to register and by monitoring for shilling activity. Inaccessibility of the auction, whether technological or otherwise, to many potential participants also results in reduced efficiency of the auction market. With the explosion of the Internet, many successful, and possibly more efficient and fair, online auction markets have been created. The trend appears to favor growth of online auction markets. There are some social and ethical issues that must be considered in designing auction markets. In electronic auction markets, the digital divide, the unavailability of communication and information technologies to individuals and organizations, can have a negative social impact on participants by restricting entry through unavailability and increased cost of technologies and through lack of understanding of appropriate technologies. An ethical issue that should be carefully monitored, in both off-line and online auctions, is the presence of collusion by participants to reduce the final bid price, thus decreasing the fair payoff to the seller.
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