Penny Auctions: What’s the Dominant Strategy?

You’ve probably seen commercials or other ads about penny auction sites such as Beezid.com or Quibids.com. On their sites, the companies sell popular items and household appliances such as laptops, phones, microwaves, etc. in live auctions and advertise savings of up to 99% off retail prices.

So how do these penny auctions work exactly?

The auctions take the form of an English auction, starting at $0 and ascending up from there. Each bid placed adds just 1 cent to the price of the item. The catch is that bidders must pay for bids. Each bid ranges from 50 cents to $1, depending on the site. Each item has a countdown similar to an Ebay auction, but when the countdown is close to zero, bids add time. For instance, if there is less than 1 minute on the countdown and a bid is placed, 10 seconds is added back to the clock. So technically, auctions have no time limit. The auction ends after no more bids are placed and the time runs out.

Is there a dominant strategy?

Typically, there is a dominant strategy for ascending or second-price auctions: bid your price. Bidding your price, not more, not less, ensures that you never get a negative payout. If you win, your payout is positive and if you lose, your payout is zero. But penny auctions differ in that if you bid even once and then lose, your payout is negative. For example, the price of an item may be at a 95% discount, but any particular bidder may have close to the full retail value of the item already invested in used bids. This style of auction may promote higher bidding. Consider a bidder who has already invested their full personal value of an item in bids, but hasn’t won the auction. Rather than giving up at that point, the bidder could end up with a less negative payoff by continuing to bid until their total investment adds up to double their value for the item – that is if they win. This added component of sunk costs complicates bidding strategies as compared to a typical ascending auction. If a dominant strategy exists, it’s likely this: stay away from penny auctions.

Articles

http://www.forbes.com/sites/nextavenue/2014/05/13/are-penny-auction-sites-seen-on-tv-for-real/#3af3828e661b

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