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  1. 1. PROJECT on GAME THEORY in AUCTION Prepared for: Assist . Prof. Dr.Uğur SOYTAŞ Prepared by: Ş. Özlem ELBEYLİ 1331297 Hüsnüye KAMANLI 1331487 Artem MYAKİSHEV 1367333 İpek ÖZKAN 1331677
  2. 2. Table of Content 1. Introduction…………………………………………………………..........1 2. General Preview of Issue……………………………………………......... 1 o Second-Price Sealed-Bid Auction……………………….…..........1 Nash equilibria of second-price sealed-bid auction……………......... 2 o First-Price Sealed-Bid Auction………………………….……......3 Nash equilibria of first-price sealed-bid auction…………………..... 4 3. “eBay”…………………………………………………………………......5 4. Modeling Auction on eBay……………………………………………......5 o First Price Sealed-Bid Auctions…………………………….…......5 o Second Price Sealed-Bid Auctions……………………………...... 6 o Example for Second Price Sealed-Bid Auction……………...........9 5. Cheating with False Bids……………………………………………......... 11 6. Conclusion................................................................................................... 12 7. References………………………………………………………..…..........13 8. Text Related Questions…………………………………………...….........14 2
  3. 3. GAME THEORY in AUCTION Introduction An auction is the process of buying and selling things by offering them up for bid, taking bids, and then selling the item to the highest bidder. In economic theory, an auction is a method for determining the value of a commodity that has an undetermined or variable price. Auctions can be with reserve or minimum, or without minimums, or absolute or no reserve. In reserve auctions, there is a minimum bid or reserve price; if the bidding does not reach the minimum, there is no sale (but the person who puts the item up for auction may still owe a fee to the auctioneer or auction company). In absolute or no reserve auctions, the sale is guaranteed, with only the price left to be determined. In the context of auctions, a bid is an offered price. For the project, we analysed a game theory in auctions, eBay. Today, these kinds of activities are very popular, and there are some kinds of web sites such as, worldwide, and, in Turkey. Most of the people prefer to buy products from these sites. Therefore, using this type of auction with game theory serves a better understanding perspective. The most important point is to see the usage and importance of game theory in daily life with conscious or without conscious. General Preview of Issue Second-Price Sealed-Bid Auction Assume every bidder knows her own valuation and every other bidder’s valuation for the good being sold Model • Each person decides, before auction begins, maximum amount she is willing to bid • Person who bids most wins • Person who wins pays the second highest bid. 3
  4. 4. Strategic game: • Players: bidders • Set of actions of each player: set of possible bids (nonnegative numbers) • Preferences of Player i: represented by a payoff function that gives Player i vi − p if she wins (where vi is her valuation and p is the second-highest bid) and 0 otherwise. Simple (but arbitrary) tie-breaking rule: number players 1, . . . , n and make the winner the player with the lowest number among those that submit the highest bid. Assume that v1 > v2 > · · · > vn. Nash equilibria of second-price sealed-bid auction One Nash equilibrium (b1, . . . , bn) = (v1, . . . , vn) Outcome: Player 1 obtains the object at price v2; her payoff is v1 − v2 and every other player’s payoff is zero. Reason: • Player 1: – If she changes her bid to some x ≥ b2 the outcome does not change (remember she pays the second highest bid) – If she lowers her bid below b2 she loses and gets a payoff of 0 (instead of v1 − b2 > 0). • Players 2, . . . , n: – If she lowers her bid she still loses – If she raises her bid to x ≤ b1 she still loses – If she raises her bid above b1 she wins, but gets a payoff vi − v1 < 0. Another Nash equilibrium (v1, 0, . . . , 0) is also a Nash equilibrium Outcome: Player 1 obtains the object at price 0; her payoff is v1 and every other player’s payoff is zero. 4
  5. 5. Reason: • Player 1: – any change in her bid has no effect on the outcome • Players 2, . . . , n: – if she raises her bid to x ≥ v1 she still loses – if she raises her bid above v1 she wins, but gets a negative payoff vi − v1. • For each Player i the action vi weakly dominates all her other actions • That is, Player i can do no better than bid vi no matter what the other players bid. Table 1. b’i < vi B’i = vi b’’i > vi I Payoff if vi - b^-i vi - b^-i vi - b^-i b^-i ≤ b’i + + + II Payoff if 0 vi - b^-i vi - b^-i b’i < b^-i ≤ vi + + III Payoff if 0 0 vi - b^-i vi < b^-i ≤ b’’i - IV Payoff if 0 0 0 b^-i > b’’i First-Price Sealed-Bid Auction Strategic game: • Players: bidders • Actions of each player: set of possible bids (nonnegative numbers) • Preferences of Player i: represented by a payoff function that gives Player i vi − p if she wins (where vi is her valuation and p is her bid) and 0 otherwise. Nash Equilibria of First-Price Sealed-Bid Auction (b1, . . . , bn) = (v2, v2, v3, . . . , vn) is a Nash equilibrium Reason: 5
  6. 6. • If Player 1 raises her bid she still wins, but pays a higher price and hence obtains a lower payoff. If Player 1 lowers her bid then she loses, and obtains the payoff of 0. • If any other player changes her bid to any price at most equal to v2 the outcome does not change. If she raises her bid above v2 she wins, but obtains a negative payoff. Nash Equilibria of First-Price Sealed-Bid Auction Property of all equilibria • In all equilibria the object is obtained by the player who values it most highly (Player 1) Argument: • If Player i ≠ 1 obtains the object then we must have bi > b1. • But there is no equilibrium in which bi > b1 : • If bi > v2 then i’s payoff is negative, so she can do better by reducing her bid to 0 • If bi ≤ v2 then Player 1 can increase her payoff from 0 to v1 − bi by bidding bi. • As in a second-price auction, any Player i’s action of bidding bi > vi is weakly dominated by the action of bidding vi : 1. If the other players’ bids are such that Player i loses when she bids bi, then it makes no difference to her whether she bids bi or vi 2. If the other players’ bids are such that Player i wins when she bids bi, then she gets a negative payoff bidding bi and a payoff of 0 when she bids vi • Unlike a second-price auction, a bid bi < vi of Player i is NOT weakly dominated by any bid. – It is not weakly dominated by a bid bi’ < bi – Neither by a bid bi’ > bi Revenue Equivalence The price at which the object is sold, and hence the auctioneer’s revenue, is the same in the equilibrium (v1, v2, . . . , vn) of the second-price auction as it is in the equilibrium (v2, v2, v3, . . . , vn) of the first-price auction. 6
  7. 7. eBay eBay is The World's Online Marketplace®, enabling trade on a local, national and international basis. With a diverse and passionate community of individuals and small businesses, eBay offers an online platform where millions of items are traded each day. Founded in 1995, eBay created a powerful platform for the sale of goods and services by a passionate community of individuals and businesses. On any given day, there are millions of items across thousands of categories for sale on eBay. Through an array of services, such as its payment solution provider PayPal, eBay is enabling global e-commerce for an ever- growing online community. How to bid on eBay: 1. When the bidders place a bid, they enter the maximum amount they would be willing to pay for the item. Their maximum amount is kept confidential from other bidders and the seller. 2. The eBay system compares their bid to those of the other bidders. 3. The system places bids on the bidders behalf, using only as much of their bid as is necessary to maintain their high bid position (or to meet the reserve price). The system will bid up to your maximum amount. 4. If a bidder has a higher maximum, others will be outbid and the highest maximum wins the item. S/he could pay significantly less than his/her maximum price! This means the bidders don't have to keep coming back to re-bid every time another bid is placed. Modeling Auction on eBay First Price Sealed-Bid Auctions In a first price sealed-bid auction, the buyers simultaneously submit bids for the good being sold. The person who bids the most wins and gets the good at the amount he bid. All bids are made simultaneously and secretly. For example, assume that the following amounts are bid: 7
  8. 8. Table 2. BIDDER AMOUNT BID Player 1 $100 Player 2 $90 Player 3 $30 Player 1 wins the auction and pays $100. In a first price sealed-bid auction, the players should always bid less than what the good is worth to them. If they bid more and win, they are worse off. If players bid what the good is worth to them and win, they really get nothing, because what they paid was exactly equal to what they got. In first price sealed-bid auctions, the players need to decide how much to risk. The lower the players bid, the greater the benefit of winning. However, the lower the chance that they will actually win. Ideally, they should attempt to estimate what other people will bid when formulating their own bidding strategy. Second Price Sealed-Bid Auctions Second price sealed-bid auctions include the type of auction effectively used on eBay. In these auctions each player secretly makes a bid, the person who bids the most wins. The winner, however, pays what the second highest person bid. In a second price sealed-bid auction, the amount that the player bid determines whether s/he wins; it does not determine how much the player pays in the case of win. In these auctions player wants to bid only when the amount s/he would have to pay if s/he won is less than the item’s value. If player bids what the item is worth to , s/he will win if and only if the second highest bid (the amount s/he pay if victorious) is less than what the item is worth. If the player knows the value of the good, and believes the auction to be honest, the optimal strategy on eBay is to bid what the good is worth to him/her and never raises his/her price. If the player bids what the item is worth, and someone bids more, s/he should never outbid her because then if player wins, s/he will necessarily pay more than the item’s value. Many people on eBay seem to follow the strategy of bidding small amounts and then raising their bid amount if outbid. This strategy wastes time, because his/her bid determines when s/he wins, not how much the player pay. To see this, assume again that the good is worth $100 to the player. Imagine that there will be many other bids, and the highest is X. If the player just 8
  9. 9. bids $100 from the beginning, s/he will win the auction when X < $100 and will pay X if s/he wins. If player initially bids $20, keep raising the bid when someone else outbids him/her, but never bid more than $100, then the rival gets the same result as if s/he just bids $100 from the beginning. The player wins whenever X < $100, and when s/he wins, then pays X. If eBay were a first price auction, where the winner always paid what he bid, then the player would always want to just barely outbid the second highest bidder. In a first price eBay auction, player would want to visit the auction just before it ended and bid just a little bit more than the second highest bidder. In fact, if everyone were rational, in a first price eBay auction, everyone would wait until the end of the auction to bid. It would be stupid to bid before the end; doing so would give the players no advantage and might even hurt them because they could end up bidding far more than everyone else. Remember, in a second price auction it doesn’t matter by how much the player outbids everyone, since if s/he wins, player always pays the second highest bid. In a first price auction, by contrast, the winner always wants to just barely outbid the second highest bidder, because the winner pays what he bids. Thus, in first price auctions, the player wants to wait until the end, when s/he has as much information as possible about the other bids. Table 3. BIDDER AMOUNT BID Player 1 $X Player 2 $Y Player 3 $Z In the following figure the values are assumed: 0<X<A 0<Y<A 0<Z<A 9
  10. 10. Figure1. There are three players in the game and player one bids for $X, Player 2 bids for $Y and Player 3 bids for $ Z, respectively. The entire players have just one chance to bid and all of them can buy that good immediately if they pay $A. The first player bids for a value $X which is smaller than $A and the second player bids for $Y smaller than $A. Then, the value 10
  11. 11. of Y can be smaller or larger than X. That is, there are two branches for player Y. The last player, Player 3, can see the price which is smaller than the highest bid. So, in the first branch where the player two plays Y>X, Player 3 can see only X and decide a bid price Z which can be smaller or greater than X. If Z is greater than Y, then player 3 wins and pays Y. Otherwise; if Z is smaller than Y, then player 2 wins the game by paying $Z. In the second branch where the two player plays X>Y, Player 3 can see the second highest price which is Y. If Z is greater than X, Player 3 wins and pays X. Otherwise; if Z is smaller than X, Player 1 wins and pays $Z for that good. Imagine that the item being bid on is worth $A to player 1. Let’s first examine why bidding $A-1 is always better than bidding some amount less than $A, such as $A-3. If the other players buy the product immediately, it doesn’t matter whether the first player bid $A-1 or $A-3 because s/he lose the auction either way. If the highest bid other than him/her is below $A-3, it again doesn’t matter whether player 1 bid $A-1 or $A-3. In both cases s/he wins the auction and pays the amount of the second highest bid. The only time there is a substantive difference between bidding $A-1 or $A-3 occurs when the highest bid made by other players else is between $A-1 and $A-3. If the highest bid made by others else is $A-2, player 1 lose the auction if s/he bid $A-3 and win the auction if s/he bid $A-1. If first player bid $A-1, s/he would get the good for $A-2, which is beneficial since the item is worth $A to him/her. Consequently, if the highest bid other than player 1’s falls between $A-1 and $A-3,player 1 is always better off bidding $A-1 if the good is worth $A to him/her. Thus, bidding $A-1 is either the same or better than bidding $A-3 or any other amount below $A. Example for Second Price Sealed-Bid Auction. i. All players can buy the good without bidding at the immediate buy price which is $100. ii. Player 1 bids for that good $70. iii. Player 2 bids for that product maximum $80 or minimum $60. iv. Player 3 has a strategy which is increasing the second highest bid $20 or $5. Draw the gametree in the light of given information and find who wins the game if Player 2 can afford only $60 and Player 3 can afford $65. 11
  12. 12. Table 4. BIDDER AMOUNT BID Player 1 $70 Player 2 $60 or $80 Player 3 If $60 then play min $65 or max $80 If $70 then play min $75 or max $90 If $75 Then play min $80 or max $95 Figure 2. So, the payoff matrix of the game is as follows: If Player 1 plays $70; Table 5. Player 3 Minimum Bid Maximum Bid Minimum Bid (0, 0, 20) (0, 25, 0) Player 2 Maximum Bid (0, 0, 30) (35, 0, 0) Cheating with False Bids A dishonest seller could use false bids to increase the amount he receives in a second price auction. To see this, assume again that the following bids are made: Table 6. BİDDER AMOUNT BİD Player 1 $100 Player 2 $90 Player 3 $30 12
  13. 13. In the light of these values, Player 1 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 Player 1 from winning, but it would cause Player 1 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 Player 1 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 Player 1, 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. 13
  14. 14. CONCLUSION As explained by the real life situations and general rules for auctions, game theory support an important perspective for them. Not just in first price sealed-bid auctions, but also in second price sealed-bid auctions, there can be played games between bidders. In this project, we played a game which includes 3 bidders who can only play once. They bid once, and can not react after. However, most of the real life situations is not so simple as it is. Players can bid more than once, and, as a result they can change their payoffs (more chance to win). Moreover; the variable price may change while the game (bidding) continues in eBay. A person who wants to maximize his/her payoff not only thinks about the risk h/she gets in, but also thinks on time h/she waits for to buy the product. Immediately buy perception do not always resulted in higher payoffs. On the other hand, the type of the auction is important. First price or second price sealed-bid auctions differs on the basic information for players. There seems to have complete information for players, but actually it is complete and imperfect information. Because players actions are secret most of the time, and the game is playing simultaneously. By the way, based on the project, we claim that everybody should consider such probabilities which were explained. Consequently, they can make different strategic decisions. 14
  15. 15. References (in alphabetical order) 1. second_price_sealed_bid_auction 2. ‘Game Theory at Work: How to use game theory to outthink and outmaneuver your competition’ by James Miller, McGraw Hill, 2003 3. 4. 5. 6. 7. 15
  16. 16. Text Related Questions Q1. What is the bid amount should the winner pay for the good in the first and second price sealed-bid auctions? • In the first price sealed-bid auctions the winner should pay the highest amount what they are bid for the good. In the second price sealed-bid auctions the winner pays the second highest bid to buy the product. Q2. What is the best strategy for the bidder in the second price sealed-bid auctions? • The best strategy for the bidder in the second price sealed-bid auctions is offering the value that the good is maximum worth for the bidder. Q3. What is “to win” the auction? • To win an auction means that buying the good at equal or less than the maximum of what the good is worth for the bidder. Q4. What is “winner’s curse”? • Winner's curse is a tendency for the winning bid in an auction to exceed the intrinsic value of the item purchased on auction sites like eBay's. Because of incomplete information, emotions or any other number of factors regarding the item being auctioned, bidders can have a difficult time determining the item's intrinsic value. It's what people suffer when they win an auction by overestimating how much something is worth and therefore bidding too much. As a result, the largest overestimation of an item's value ends up winning the auction. 16
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