What’s it: An auction is a selling method where prices have not yet been set and are determined through an open and competitive bidding process. The auctioneer acts as the selling agent in most cases and receives a commission on the sale price.
The auction is important because it is a way of finding an equilibrium price rather than being set by the producer. In the simplest of auctions, English auction, the auctioneer starts bidding at a specific price. Then, a bidder submits a higher price.
The auctioneer then uses the price and offers it to other participants if there are still those willing to bid higher. Other bidders may ask for a higher price. Then, the auctioneer raised the price. The process continues until no one wants to bid higher.
Auctions usually bring together buyers and sellers to the same location at the same time. Bidders are usually physically in the same room. However, they may be in a different location in some cases, such as in an online auction.
Why is auction important
Auctions are an effective way of determining the market price of goods. Auctions are usually for the sale of antiques, paintings, rare collectibles, and expensive wines. Under conventional trading, it is difficult to determine their market price. Therefore, one way to determine it is through an auction.
Auctions are also common in the financial industry. The issuance of government securities in the primary market usually takes place by auction.
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Furthermore, the size of the auction market is also very significant. For art alone, global sales totaled $67.4 billion in 2018, with around 84% from the US, UK, and China markets. For the United States market, sales totaled $ 29.9 billion for the year. In 2019, the three auction houses’ annual revenue, Christie’s, Sotheby’s, and Phillips, totaled $10.4 billion.
Types of auction
You may see a wide variety of auctions. And in this article, I’m going to cover the following four types of auctions:
- Open ascending price auction
- Open descending price auction
- First price sealed bid auction
- Second price sealed bid auction
Open ascending price auction
The open ascending price auction, also known as an English auction, is the most common type of auction. The way it works is relatively easy.
In this auction, the auctioneer starts at a certain price. Participants bid openly to each other. The next bidder must submit a higher price than the previous bid.
When the auctioneer announces a price, the bidders state their bid at a higher price. The auctioneer then uses that price to propose to other participants. The other participant then increases the bid price. The auctioneer uses it to offer it back to the other participants. The process continued until none of the participants wanted to bid further. At this point, the highest bidder is the winner and pays according to their bid.
The buyer may not be a bidder and not be physically present at the site. They ask representatives to bid on their behalf.
Furthermore, in an online auction, participants submit bids electronically. The highest bid is displayed publicly so that participants can use it as a boundary for submitting their next bid.
Open descending price auction
The open descending price auction begins when the auctioneer initiates bidding at very high prices for some similar items. Participants can buy as many units as they want at a certain price.
If the first bidder does not purchase all of the units, the auctioneer will lower the remaining units’ price. If the second bidder also does not buy the remaining units, the auctioneer reduces the price again. The process continues, and prices continue to fall until all units are bid on. Or it is until the seller’s reservation price is fulfilled.
Allocation of items according to the bid order. The highest bidder chooses their item first and gets what he bargained for. The next allocation is for the second bidder, and so on.
First price sealed bid auction
Under the first price sealed bid auction, auction participants can only submit one bid. They do not know the offers from other participants. The auctioneer then opens all participant bids to determine the winner. The participant who offers the highest price wins, and he or she pays the price according to the bid.
This type of action gives rise to a winner’s curse. Each participant gives their own valuation of the item being auctioned. That results in a wide variety of bidding prices.
Furthermore, a participant also does not know the bid prices of other participants to make comparisons. Thus, when he wins the auction, he may pay a price that is too high than the asset’s real value.
For such reasons, participants will be careful when submitting bids. And that caution may have the opposite effect. The participant submits a low bid price, lower than the auctioneer expected. This is, of course, detrimental to the auctioneer.
Second price sealed bid auction
Another term for a second price sealed bid auction is the Vickrey auction. This is the variation of a first price sealed bid auction.
Participants submit written bids without knowing bids from other participants. The auctioneer then opens all bids simultaneously. The highest bidder wins but pays the same price as the second-highest bid.
Both a first-price sealed-bid auction and a second price sealed bid auction have several weaknesses. Participants are likely to conspire to disclose their respective offers implicitly. That way, when a participant charges too high, he or she can adjust it downward.
Another disadvantage is that an auctioneer uses multiple identities to bid and increase profits.