(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 543
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518 PART 3 • Market Structure and Competitive Strategy
• common-value auction
Auction in which the item has
the same value to all bidders,
but bidders do not know
that value precisely and their
estimates of it vary.
2. In common-value auctions, the item to be auctioned has approximately
the same value to all bidders. Bidders, however, do not know precisely
what that value is—they can only estimate it, and bidders’ estimates will
vary. For example, in an auction of an offshore oil reserve, the value of the
reserve is the price of oil minus the extraction cost, times the amount of oil
in the reserve. As a result, the value should be about the same for all bidders. However, bidders will not know the amount of oil or the extraction
cost—they can only estimate these numbers. Because their estimates will
differ, they might bid very different amounts to get the reserve.
In reality, auctions can have both private-value and common-value elements. In the oil reserve auction, for example, there may be some private-value
elements because different oil reserves may entail different extraction costs.
However, to simplify matters we will separate the two. We begin our discussion
with private-value auctions and then move on to common-value auctions.
Private-Value Auctions
In private-value auctions, bidders have different reservation prices for the
offered item. We might suppose, for example, that in an auction for a signed
Barry Bonds baseball, individuals’ reservation prices range from $1 (someone
who doesn’t like baseball but is bidding just for fun) to $600 (a San Francisco
Giants fan). Of course, if you are bidding for the baseball, you don’t know how
many people will bid against you or what their bids will be.
Whatever the auction format, each bidder must choose his or her bidding
strategy. For an open English auction, this strategy is a choice of a price at which
to stop bidding. For a Dutch auction, the strategy is the price at which the individual expects to make his or her only bid. For a sealed-bid auction, the strategy
is the choice of bid to place in a sealed envelope.
What are the payoffs in this bidding game? The payoff for winning is the difference between the winner’s reservation price and the price paid; the payoff
for losing is zero. Given these payoffs, let’s examine bidding strategies and outcomes for different auction formats.
We will begin by showing that English oral auctions and second-price
sealed-bid auctions generate nearly identical outcomes. Let’s begin with the
second-price sealed-bid auction. In this auction, bidding truthfully is a dominant
strategy—there is no advantage to bidding below your reservation price. Why?
Because the price you pay is based on the valuation of the second highest bidder, not on your own valuation. Suppose that your reservation price is $100. If
you bid below your reservation price—say, $80—you risk losing to the secondhighest bidder, who bids $85, when winning (at, say, $87) would have given you
a positive payoff. If you bid above your reservation price—say $105—you risk
winning but receiving a negative payoff.
Similarly, in an English auction the dominant strategy is to continue bidding
until the second person is unwilling to make a bid. Then the winning bid will be
approximately equal to the reservation price of the second person. In any case,
you should stop bidding when the bidding reaches your reservation price. Why?
Because if you stop bidding at a point below your reservation price, you risk
losing a positive payoff; if you continue beyond your reservation price, you will
be guaranteed a negative payoff. How high will the bidding go? It will continue until the winning bid is approximately equal to the reservation price of
the second-highest bidder. Likewise, in the sealed-bid auction the winning bid
will equal the reservation price of the second-highest bidder. Thus, both auction
