An auction is a method by which goods or services can be sold and bought. In an auction, the price of an item is not fixed in advance. People wanting to buy the item say how much they are willing to pay for it. This is called their bid. In each round, the bids are evaluated. If certain criteria are met, the auction is stopped and one bidder will buy the item at the specified price. Alternatively, the auction can continue for another round. If certain conditions are met, the auction will stop, and the item will not be sold. There are different kinds of auctions, with different rules.
Auctions usually happen within a given timeframe. When the time expires, the bid that best matches will win, or the item will not be sold.
There are companies that specialize in doing auctions. These companies will charge fees for doing the auction; they may also get a commission that depends on the price the item is sold at.
Auctions can be done online, or they can be done offline. Sometimes, bids are placed by telephone, or over the internet.
Most common kinds of auction change
The most common kinds of auction are:
- English auction: the highest bidder wins. The auction starts at the lowest price the seller is willing to sell at, and the price goes up as long as someone is willing to pay a higher price.
- A Dutch auction goes the other way round: The auction starts at a high price, and goes down until someone is willing to buy. Before the auction, the seller sets the lowest price they'll sell the item for, and if the auction reaches that price without anyone buying, the auction is stopped without selling the item.
- Sealed first-bid auction: All the bids are submitted at the same time, without any of the bidders knowing each other's bids. The bidder with the highest bid wins.
- Vickrey auction (or sealed-bid second-price auction) : This kind of auction works the same as the sealed first-bid auction, but the bidder only pays the second-highest price. This kind of auction is very important in economic theory, but isn't used as much in real life.
The mechanisms why auctions work change
Auctions work because of information asymmetry: The seller wants to sell at the highest possible price, and the buyers want to pay as little as possible.But the seller does not know the prices the buyers are willing to pay: Setting a price that is too hight means that there will be no sale, setting a price that is too low means that there will be less profit. Each buyer knows how much he is willing to pay, but does not know the price the other buyers are willing to pay. So buyers influence each other. The theory that models these phenomena is called auction theory. It is based on game theory and microeconomics.