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Bidder beware

The Economist, in an article analyzing why the inefficiencies of many auction systems have disappointed economists, describes an interesting phenomenon called the "winner's curse."

The coinage seems to be the work of Jeremy Bulow and Paul Klemperer, authors of a paper called "Prices and the Winner's Curse". The curse is fairly simple. Imagine an auction with a large number of bidders. Suppose that the bidders, as a rule, have imperfect knowledge of the actual value of the item up for auction (perhaps because that value depends on future events or conditions, or on present conditions that aren't perfectly known). In this case, the highest bidder — i.e., the winner — of the auction is likely to be someone who overestimates the auction's value, because the better a bidder's information, the closer his maximum bid will be to the real value, leaving only the overly optimistic in the bidding at the end.

In real-world auctions, bidders are not only aware of the winner's curse, they compensate for it: The greater the total number of bidders at an auction (and, accordingly, the greater the chance that, for any given bidder, some other bidder knows more than he or she), the lower the price the auction will often yield. No bidder wants to get caught paying too much.

The Economist suggests that the winner's curse is a possible explanation for many online auction websites' failure to prosper. eBay, the Economist notes, is an exception, but the magazine doesn't stop to wonder why. One possible explanation, I think, is that many bidders on eBay auctions (I believe — I was unable to find any data to back this up, however) are individuals (i.e., not businesses) who purchase items not just for economic value, but for personal value as well. These bidders needn't fear the winner's curse, because the amount they are willing to pay isn't determined by a desire for profit, but whether the item is worth it to them.

This is bad news for economists, of course, if they want to determine all the rules that govern people's bidding habits — an item's personal value is hardly governed by the market. But it's good news for eBay, and for all us non-economists, who can feel good about buying things we want regardless of what they might be worth to someone else. After all, money isn't everything.

July 3, 2002 11:36 AM

Comments (and TrackBacks)

I think the value-to-me factor is a big element to eBay's relative success as a web-biz. But, that other auction sites fell down, despite this, also means to me that eBay has the necessary mass to capitalize upon this.

Another, minor factor too, is that its fun. I have more than one friend who has either a box or space dedicated to items they're currently selling on eBay -- not cause they need to eat this month, just because the process is fun. And, probably, there's a notion that they're being thrifty.

People love to think themselves thrifty.


Posted by rob adams on July 3, 2002 4:53 PM

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