Amount bid by the second highest bidder this is also

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amount bid by the second highest bidder. This is also known as a ‘Vickrey’ auction and has the benefit of being compatible with people's true preferences. It is the only auction where it is rational to bid your true value. This is because if you bid any less than your marginal value you may lose the auction even though you wanted to win. And if you bid more than your marginal value you may win when you wanted to lose. Thus the best strategy is to bid your marginal value. It is intuitively reasonable, and theoretically provable, that the results of an English auction will be the same as a second price sealed bid. And a Dutch auction will mimic a first price sealed bid. The above holds for single asset auctions. If there are multiple assets being auctioned CHAPTER 3 Market Exchange 55
there is a choice between being a uniform price (i.e. winners all pay the same amount), or price discrimination (i.e. winners pay different amounts). Auction theory is popular because it demonstrates how blackboard theory can translate into real world outcomes. When the UK government wanted to auction off 3G licences they turned to a group of academic economists. By understanding auction theory, and testing it in a classroom with students, Ken Binmore and Paul Klemperer made their recommendations. The results were astounding. It raised £22.5bn, which equates to around 2.5% of GNP. 16 Markets are a discovery mechanism as much as an allocation one. 3.3 INFORMATION ECONOMICS This may all work in theory, but how do markets function in practice? Even if prices are allowed to adjust, are markets perfect? Although it's true that economists tend to put a lot of trust in the ability of markets to find equilibrium, economists also spend a lot of time considering instances where they fail. There are a number of examples of ‘market failure’, one of which is the concept of asymmetric information . This occurs when actors on one side of the market have better quality information than those on the other. If we're buying and selling eggs, information is reasonably symmetrical. An egg is an egg. But in some situations it's hard to know the exact characteristics. Imagine a company that offered to pay £200 to anyone that had a skiing accident. Here the information is highly asymmetric, because you are likely to know whether you're a safe or reckless skier. But this isn't obvious to the company. You have better quality information than they do. We can see two implications of asymmetric information. 1. Adverse selection In our example, the skiers most likely to buy the product are the most accident- prone. If the odds of an accident are calculated across all skiers, the company will suffer from a selection bias. The insurance is attracting the ‘wrong’ kind of person. 2. Moral hazard Even if the skier is a reasonably safe one, if they buy the insurance it will affect their incentive to ski safely. At the margin the insurance will encourage them to be more risky, and therefore make it more likely that they have an accident. It's a bit like wearing a helmet – the insurance changes people's incentives and therefore changes behaviour.

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