Auctions -- The Vickrey Auction
-by Kate Reynolds
One in a Series of Articles from Agorics, Inc.The uniform second-price auction is commonly called the Vickrey auction, named after William Vickrey, [Vickrey] winner of the 1996 Nobel Prize in Economic Sciences, who classified it in the 1960s. Like the first-price auction, the bids are sealed, and each bidder is ignorant of other bids. (In the financial community, the uniform, second-price auction is called the Dutch auction, but in these papers we will use the academic names.)
The item is awarded to highest bidder at a price equal to the second-highest bid (or highest unsuccessful bid). In other words, a winner pays less than the highest bid. If, for example, bidder A bids $10, bidder B bids $15, and bidder C offers $20, bidder C would win, however he would only pay the price of the second-highest bid, namely $15.
There is one interesting and crucial point and that is that when auctioning multiple units, all winning bidders pay for the items at the same price (the highest losing price). We will see later that the U.S. Treasury Department is experimenting with this type of auction to sell the national debt.
One wonders why any seller would choose this method to auction goods. It seems obvious that a seller would make more money by using a first-price auction, but, in fact, that has been shown to be untrue. Bidders fully understand the rules and modify their bids as circumstances dictate. In the case of a Vickrey auction, bidders adjust upward. No one is deterred out of fear that he will pay too high a price. Aggressive bidders receive sure and certain awards but pay a price closer to market consensus. The price that winning bidder pays is determined by competitors' bids alone and does not depend upon any action the bidder undertakes. Less bid shading occurs because people don't fear winner's curse. Bidders are less inclined to compare notes before an auction.
This type of auction has been used in former Czechoslovakia to refinance credit and in Guinea, Nigeria, and Uganda for foreign exchange.
What about changing the format just a little and having a second-price, open-outcry auction? In such a case, participants could bid in the ascending format and the winner would ultimately pay the price of the second-highest bid. One might imagine that such an auction would have much the same results as an English (ascending, open-outcry) auction, but, in fact, an auction like that would be easy to manipulate. Imagine bidder A bidding $25 for an item worth $100. Some other bidder could quite easily and safely bid $750, knowing that no one will bid more and that he will only pay $25. Clearly it is imperative to seal the bid.
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