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research proposal - Consumer Collusion in Auctions on the...

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Consumer Collusion in Auctions on the Internet By: Andrew Rapaport Most consumer-to-consumer Internet auctions are isomorphic to the English auction. Bids in these auctions are visible to all participants, and prices are always ascending. The success of these auctions have puzzled auction theorists because many of the procedures used in these auctions encourage collusion among buyers that leads to lower revenues for the seller and sometimes lower allocative efficiency of the auction outcomes. Using the institutional analysis approach and results from experiments, this paper attempts to explain why open ascending auctions have dominated the Internet auction landscape even though they might not be the most profitable alternative for sellers. Estimates of efficiency losses in these auctions due to implicit collusion among consumers are also provided.
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Introduction The invention of electronic markets has challenged market designers to invent new exchange systems. Currently most on-line auctions including eBay, Amazon, Yahoo and others follow the general English auction pattern with a few differences. The science of market institutions has received much attention in the last few years. The Nobel Prize in Economics and Behavioral Sciences in 2002 was awarded to Vernon Smith, who is one of the pioneers in this area. One of the main principles of market institutionalism is that the rules of a given market are important; they affect human behavior and thus market efficiency and prices. Setting aside the problems of reputation and trust, and focusing on the auction procedures used by many auction sites, one can find several institutional loopholes that allow buyers to collude implicitly and thus try to strategically manipulate prices. This might make the auction more interesting, but often comes at the expense of a decrease in efficiency of the auction’s outcome. The specific rules that can lead to implicit collusion among buyers are: 1. Some websites (e.g. Yahoo) implement a minimum increment rule, i.e. every new bid has to be greater than or equal to the last new bid plus a certain increment, which changes depending on the size of the last new bid. However, there is no upper limit on any new bid. Bidders can often use bids larger than the minimum increment as signaling devices for other bidders. This strategic signaling behavior is referred to as “jump bidding”. A bidder bids high above the minimum increment in the very beginning of an auction thus sending a signal to the other bidders to discourage their participation. The size of the increment does not matter. It is the importance of the signal of bidding high above in the very beginning that silently invites other buyers to collude.
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