Economic Classroom Experiments/The Twenty-Pound Auction

On February 7th, 2007 at the FDTL conference in Bristol, Todd Kaplan ran auction for a real £20 note as part of a 7 minute presentation. It was great fun. It is very quick to run and easy to set up.

Procedures
Pass out slips of paper or post-its to record bids. Announce that you are auctioning off a £20 note to the highest bidder. Ask them to write their name and their bid on the slip of paper or post-it provided. The winner will be the one with the highest bid with ties broken randomly. Collect bids and pay winner.

Required Time
Announcement of rules: 1-2 minutes. Collecting bids: 1-2 minutes. Counting bids: 2-3 minutes. Announcement of winner (and payment): 1 minute. Discussion: varies.

Materials

 * a £20 note.
 * Post-its or slips of paper.
 * Change to pay the difference to the winner.
 * A plastic bag to collect the bids (helpful, but not necessary).

Results
Tony (from UCL) won the auction with a bid of £20.01. (Todd made a penny!) Tony said that he got twenty pounds worth of money and one penny worth of fun.

Todd's money wasn’t too much at risk. Of the twenty bids (including two with missing names), seven were above £17.5 and five of those above £19. See the following histogram for the bids.

Discussion
This is called a first-price sealed-bid auction since bids are sealed and the winner pays his bid. It can be described as a common value auction since everyone has a common value to winning (as opposed to private values). Equilibrium theory would predict that as long as there are 2 or more bidders the price would be £20 (or even £19.99). This is because that if the highest bid X were below this, then another bidder would have incentive to bid X+£0.01 and make a profit. Theory tended to work well here. From this, you can see that Todd put my money where my mouth was. Todd's faith in the economic behaviour of the audience was high enough to risk losing cash (not to mention the potential embarrassment). This also mirrors what is called (Bertrand) price competition where the consumer buys from the lowest price firm. There the firms are like the bidders and the consumer is like the auctioneer. In this case, competition should drive out profits from the industry in a similar manner to profits being driven out of the auction. This also leads us to competition, cooperation, and collusion. While there are many firms/bidders, the profits are low. Would we expect this to happen with only two bidders?

Finally, what happens if we relax our assumption about it being a common value auction? This can happen if people like Tony place different values to winning the auction for instance there is a psychological aspect to winning. If people know for sure their psychological value to winning then they would enjoy some profit and could bid below their true value. However, if these are only estimates to the enjoyment, then there could be what is called a winner’s curse and the one that wins it may be prone to paying too much and regretting it later. As you can see, there is a lot to this simple game.

Tips

 * 1) Probably, the higher the denomination the better this would work. (Slightly higher risk for the lecturer).
 * 2) You can use it to demonstrate other auction rules such as English (open call) or 2nd –price sealed-bid (the winner is the one with the highest bid and pays the second highest price).
 * 3) If the winning bid is much less than £20 pounds, you can mention prior results or run it again.
 * 4) While there are no guarantees, I imagine with 10 or more people you are pretty safe not losing much money.
 * 5) As pointed out to me, make sure you say the bid should be in pound Sterling not just pounds (one can bid in pounds of carrots). You may also want to require bids to be above or equal to zero.
 * 6) While it doesn’t take long to see who is the winner (a minute or two), you may want to have someone else quickly go through the bids to find the winner and announce it at a convenient time later. Alternatively, wait for a break to collect the bids to save time and continue with my presentation.
 * 7) Pass out the Post-its or slips of paper beforehand.
 * 8) Stress that this is for real money (the note is real).
 * 9) You can use one of the coins from your change to break a tie.

First Created by --Toddkaplan 20:13, 7 April 2007 (UTC)