A locus for eccentrics (hopefully)

Tuesday, November 14, 2006

It's the Economy, Stupid

You can imagine my despair upon learning that the recent spending orgy among Major League Baseball franchise to secure the rights to negotiate with Daisuke Matsuzaka was a sealed first-price auction.

Economically efficient auctions attempt to identify the bidder who would get the greatest utility out of the good, but not allow losing bidders to inflict some sort of disutility on the winner by bidding up the price insincerely or allow the winner to try to scootch down from their true valuation of the good to somewhere just barely more than the second-price bidder. If you've ever played Monopoly with the official rules, where you have to auction unpurchased property immediately after someone lands on it and refuses to buy, you have a sense about why that's a hassle. Sealed first-price auctions are a little better than that, but far from the best.

A prominent and simple efficient design was developed by Vickrey and extended by Myerson (1981), who showed that a sealed second-price auction--the person who bids highest wins, but they only pay whatever the second-highest offer was--is economically efficient and equivalent to any other efficient auction design. Historians will also note that a nested second-price auction design was used by myself and my two housemates last year to figure out who would get stuck with the tiny, or "bitch," room.


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