Cheating with False Bids

As before, Tom will win the auction and pay $90. If the seller knew the bid amounts, however, she should bid $99 herself. Such a bid would not prevent Tom from winning, but it would cause Tom to pay the seller $99 rather than $90. The seller, of course, would not want to bid more than $100, for this would cause the seller to win her own auction.

On eBay a seller would not know all the amounts bid. If the above three bids were made, eBay would show that Tom was the high bidder but would indicate that the current price was $90. Consequently, a new bidder wouldn’t know how much he would have to bid to become the high bidder. Thus, a seller making false bids would be taking a chance if he bid more than $90. He might get lucky and bid less than Tom, but he also could bid too much and win the auction himself. If the seller won, he could auction off his good again or withdraw his bid. Both strategies have some drawbacks since sellers must pay eBay a fee for every completed auction and eBay imposes limitations on when a buyer can withdraw a bid.

If eBay allowed it, however, a seller could greatly benefit from making false bids and then withdrawing them if they were too high. A seller could keep raising her false bid by $1 until she won. She could then withdraw her final bid and thus get the maximum possible amount for her product. Making false bids constitutes criminal fraud, however, so a seller engaged in such a scheme would have to be careful about withdrawing too many bids, or eBay might catch on. Presumably eBay understands how sellers could use false bids to fraudulently increase their take, so eBay probably investigates at least some withdrawn bids. If you won an auction in which a bid was withdrawn, however, you should beware that a seller might have been trying to illegally increase the amount you had to pay.

If you fear that a seller might make false bids to increase his price, you should consider bidding only at the conclusion of an auction. This way a seller won’t have the opportunity to test you with false bids.

Winner’s Curse

Sometimes winning an auction signals that you lost. Although in the previous sections it was assumed that you knew how much the good was worth to you, sometimes you don’t have full information about the good’s quality. For example, imagine that several oil companies are bidding for the mineral rights to some land. Each oil company sends a team of geologists to determine the likelihood of the land having oil. No company knows everything, and all companies unearth some slightly different information. Let’s say 10 companies bid, including yours. You win, and it turns out you bid far more than most people. This means that your geologists thought that the land was more valuable than the geologists at the other companies did. There are now two possibilities: Everyone else is wrong and your geologists correctly determined the value of the land, or everyone else is correct and you overbid. While your geologists might be the best, the odds favor your having made a mistake.

Consider a simple analogy. You are in a room with 10 other people. You ask each person to guess your weight. Chances are that the person who guesses the highest overestimated your weight. The winner of an auction is the person who guessed that the good being sold has the highest value, and so odds are that he overestimated the good’s value.

Winner’s curse applies only when you are uncertain of the good’s value. Imagine that you are determined to buy my book, which is being sold for, say, $30 at your local store. Before purchasing it, you decide to check for a copy on eBay. If you are definitely going to buy my book, you know it’s worth paying up to $30 because that’s how much getting the book on eBay would save you. There can be no winner’s curse in this example because if you pay less than $30 (including shipping), you are better off.

Now imagine that you first encounter my book on eBay. Many people place bids, but you win. You must have a higher estimate of my book’s value than any other seller does. Maybe you have insight into my brilliance that others lack. But perhaps you have overestimated my literary worth.

When you are uncertain of a good’s value, then you learn something from everyone else’s bid. High bids signal that others greatly value the good, while low bids show that your fellow bidders don’t think the item has much worth. If the other bidders might know something about the auction item that you don’t, then their bids should influence how much you are willing to pay.

Winner’s curse afflicts sellers as well as buyers. When buyers are uncertain of a good’s value, then they fear paying too much. Winner’s curse will cause all buyers to bid less and will consequently reduce the seller’s take. To combat winner’s curse, sellers need to provide information about their goods so that buyers will realize the good’s value and won’t fear the winner’s curse.