My wife is currently playing on Neopets. This is a “virtual pet community,” which is a fancy way of saying a social website based around cute mythical cartoon animals. I think this is weird because she works for an animal rescue group in the real world. To put it nicely, she is much older than the average player. I watch mindless TV and read comic books when I get home, so I cannot say too much.
The site has virtual merchandise, games that give you points, the option of spending real money, shops and auctions. In short, it is a model economy with perfect controls. The number and weight of, say, watermelons on Neopets varies from day to day. Try doing that in the real world!
What Jackie has observed is that the kids have no idea how markets and auctions work. There are lists which function like the “Kelly Blue Book” of the non-existent; they compute a price for an item based on the number in the virtual space and offered for trade. The kids take these prices as a Law of the Universe. Any other pricing mechanism is somehow “not fair” to them.
This is really unfortunate since they live in a real world of eBay.com, craigslist.org, stock markets and bargain shopping via search engines.
First PrinciplesThe first principles of a market are pretty simple.
- Not everyone values things the same. A lobster dinner looks good to me, but deadly to someone with a shellfish allergy.
- Valuations change over time. I might eat a second lobster dinner immediately after the first one, but a third lobster is too much to eat right now. Call me next week, please.People do not trade unless they feel what they gain is more valuable than what they lose. I want that lobster dinner more than I want the $25 in my pocket. But I want $50 in my pocket more than a lobster in my belly.
General Types of BiddingBids have to stop at some point in time, so there is usually a deadline. They can be sealed-bid, where each bidder has a fixed number of bids (usually one) that they traditionally submit in an envelope. Open bid auctions are more lively; the bidders call out their offers until the auctioneer closes the bidding. You can enter and leave the auction at will.
These days, we do it online, so we have “bid snatcher” software that automatically submits a bid that is under your pre-set limit. The usual strategy is to wait until the last possible minute (second? micro-second?) to get in a bid in so short a time slot that nobody can type fast enough to beat you.
General Types of AuctionsAuctions come in all kinds of flavors, but the basic parts are an offering of something (“I have here a first edition of CAPTAIN BILLY’S WHIZBANG, 1919! I start the bidding at $500!”) and bids (“I’ll pay $1000 for it!”). The bid can be accepted or rejected.
English Auctions are also known as increasing or ascending price auctions. The auctioneer asks for starting price and the bidders increase the price until the item sells or the price offered is not high enough and the auction fails. This is the form that most of us know. It is how eBay works.
The Japanese auction is an ascending price auction with levels or tiers. Once you drop out, you cannot re-enter the bidding. For example, if the starting bid $10, every interested bidder agrees to meet it. We then go up a level or $15; anyone who fails to meet the new level is out and cannot re-enter the bidding, even if they are willing to pay a higher price later. You have a lot of information – the number of other bidders at every level and their exit prices. The auction continues until only one bidder remains.
Dutch Auctions are also known as decreasing or descending price auctions. The auctioneer asks for high starting price, then drops the price lower and lower in steps until the item clears or auction fails. This form of auction used to be popular with small retail stores decades ago. The items would be put in the store window with a flip-chart price tag and an announcement that the price would decrease $x per day until sold.
Today, the Dutch auction is hidden in online clearance sales. Instead of looking at the store window on main street, you get a series of email advertisements at lower and lower prices.
Obviously, a winner can have “buyer’s remorse” – the feeling that they paid too much for the item. If you have seen bidding wars on eBay or real life, you understand how emotions can get mixed up in the heat of the moment.
The solution is Vickrey or second price auctions. The highest bidder wins, but the price paid is between the highest and second highest bids. The winner cannot be unhappy; he paid less than his bid and won. The losers cannot be unhappy; they all bid less than the winner.
The eBay proxy bid system is a form of second price auction. A variant of a Vickrey auction, named generalized second-price auction is used in Google’s and Yahoo!’s online advertisement programs.
Auctions are a classic way of finding a price point. And they are easy to automate. You really ought to know about them.
- Benjamin Edelman, Michael Ostrovsky, and Michael Schwarz: “Internet Advertising and the Generalized Second-Price Auction: Selling Billions of Dollars Worth of Keywords.” American Economic Review 97(1), 2007 pp 242–259.