The Value of Minimum Prices in Auctions

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Introduction

Auction is a process that involves buying and selling goods and services on a bid-offer whereby the highest bidder wins the market. There are however some rules and guidelines which regulate the bidding process. These rules are usually set in order to safeguard the interests of the participants and the auctioneers, since the identities of the two parties may be unknown. The most commonly used type of auction is the English auction. In this form of auction, the participants get to bid against each other and the subsequent bid is always higher than the previous one. The English auction is also referred to as an open ascending price auction due to its pricing nature. There is a minimum price which is usually set by the auctioneers and this price limits the participants not bid any price below it; the minimum price usually indicates the economic value of the product or service. This paper seeks to analyze the valuation of the minimum price in an auction.

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Terms commonly used in Auction

It is important to understand some of the terms that are commonly used in the auction process. Firstly, the minimum price in an open ascending price auction plays a significant role in the overall bidding process. This is because the price usually tells more about the quality and the economic value associated with the product or service. If the price falls below the participant’s expectations, then an automatic negative response will be sent into their mind. As it is commonly known, low-quality products usually have a lower economic value attached to them. The minimum bidding price is sometimes disclosed to the participants since it acts as the price floor. The price floor is the price below which an item is better off unsold. It is however common that despite the fact that the seller has similar products to be auctioned, different minimum prices will be used for each. According to the seller, the products might be similar but the acquiring process is different thus resulting in the price variations (Ockenfels, Reiley & Sadrieh, 2006).

Secondly, there is a secret minimum price. This is the price set by the seller in order to determine the lowest value that a product can fetch in the market. This price is usually not disclosed to the participants but is only displayed by the seller’s action of not hammering down after the bidding process. The secret minimum price is usually set in order to give the participants power to determine the best price which can be attached to a certain product. During the traditional auction process, the seller fails to hammer down, thus signifying that the good ownership cannot be passed to the highest bidder. In the case of an eBay auction, the seller usually informs the bidder of the existence of the secret minimum price. The secret minimum price indicates the minimum selling price that the seller intends to sell the product to the highest bidder. The major reason why the price remains secret is to allow the participants to bid a higher price. The secret minimum price enhances competition between the bidders and at the same time, it discourages them from purchasing items at a lower revenue rate (Katkar & Reiley, 2005, p.5&6).

Thirdly, the term minimum bid is used to refer to the smallest but acceptable price in an auction. The minimum bid, therefore, ranges within the acceptable price which the seller can opt to sell his or her product. The major characteristic of this price is that there exists a higher price above it. The seller will accept any bid above or equal to the minimum bid but will refuse any bid below this level. According to Hendershott (2006) the minimum bid is the commonly used reserve price in online auctions. The price indicates the lowest offer in which the seller can offset the product during an auction. The price is usually announced before the auction begins and therefore it’s hard to alter this price later in the process.

Fourthly, there is the shill bidding which is a more recent version used in the selling of the merchandise. The shill bid can be used to purchase goods meant for resale purposes since the bidder can obtain goods at a relatively lower price then resell them at a higher price, making good profits. Nevertheless, this form of the bidding process is suitable for expensive items only. The shill bidders mostly target the sellers who have very little information concerning the goods.

Fifthly, there is a participation fee that allows the participants to bid in an auction. The fee is mainly set by the firm mandated to undertake the auction activity and varies between different firms. The fee mostly includes the registration for service and aims at ensuring the full participation of the members in the auction process (Paley, 2006, p.330).

Main theoretical insights

According to the auctioneers, the best price to sell a product is the one that maximizes the expected income. This maximizing price is also called the optimal reserve price. It is due to this reason that the seller will always go for the highest bidder during the selling process. The seller also has an optimal reserve price which sometimes tends to be higher than the highest bidders price. If this is the case, the seller just refuses to sell the product. The optimal reserve price should always be equal to the price in which the auctioneer would be willing to sell the product and in this case, the price will limit the seller if the highest bidder fails to attain it. It, therefore, acts as a control price that is meant to ensure efficiency in the auction process. The optimum reserve price can however be altered if the seller wishes to do so.

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The eBay and online auctions notify the participants of the presence of a secret price and also whether the bidders have met it in due bidding progress. This, therefore, encourages openness in the auction process. The seller does not inform the participants of the shill bidding, but the participants can guess depending on the techniques used in the auction. The information and notification of the participants during the auction are not only theoretically important to the process but are also supported by law (Milgrom, 2004, p.187). The traditional auction mainly has the secret reserve price which is only known by the seller, therefore mandating him or her to play about with the figure. The seller therefore can optimize his return by ensuring that only the bidder who meets the target secret reserve price takes the day. The traditional auction acknowledges the highest bidder as the winner of the bid during the auction process. The seller then hammers down confirming the end of the bidding process which gives the highest bidder the ownership right of that given product. But the sale is completed if the highest bidder attains the secret reserve price. Otherwise, the seller does not in any case hammer down the auction.

The presence of all the above prices in the auction process guides and regulates the auction undertakings since the prices limit both the seller and the buyer’s actions. The auction, therefore, safeguards the interests and welfare of the buyers (Hendershott, 2006, p.584).

Reflections on efficiency implications

The classical model allows the price adjustments to be coordinated by the forces of demand and supply. The firms also greatly determine the prices of goods in the market. The selling price in this case includes the original cost of the product, the transport and other relevant expenses associated with the product, and the profit margin. The price, therefore, tends to be relatively higher since the main objective of the market is to maximize profit. Most of the prices in the classic model are transferred from the manufacturer down to the retailer, making it hard for the retailer to charge a lower price (Groves, Radner & Reiter, 1987, p.287). Other fixed costs affect the pricing of the goods in the classical model. Such prices include the rental and administration charges that are frequently incurred in the daily running of the business. Because the seller cannot take full responsibility for these costs, he or she passes the cost burden to the consumers by charging a price relatively higher than others.

The prices of goods can nevertheless be lowered through increased competition in the sector. If many firms are engaged in a specific industry, then they will be forced to lower their products’ prices in order to enhance competitiveness. Mass production in many firms also lowers the production cost, resulting in a reduction in prices. The competition and mass productions, therefore, lead to reductions in prices in the market. The consumer’s welfare is therefore improved through the increased quality productions and reduction in prices of goods and services in the market. Indeed, the competition between firms encourages price adjustments in favor of the consumers (Fischer & Rotemberg, 1994, p.93). Conversely, if one or few firms happen to monopolize their production, they can end up charging higher prices since consumers will have no alternative choice available for them.

On the other hand, an auction process is an occasional event used by the owners to recoup their invested amount. Financial institutions are the major sectors that seek the assistance of the auctioneers in order to enable them to recover the amount rented out in form of loans. Since these institutions will only agree to take collateral that has a higher value than the amount advanced in form of loans, the institutions will only aim at recouping their principal amount plus interests. The secret reserve price, therefore, tends to be minimal compared to the market value. For this reason, the auction minimum price is always below that of the classical model.

Many people prefer buying their properties and goods from auctioneers since they save on costs as they purchase quality products at considerably lower prices. The modern auction process also allows similar prices for similar products, thus improving the past behavior which prevailed in the auction market. The economic welfare of the consumers is therefore taken care of by the reduced prices involved in the auction. In most cases, a rational consumer will tend to go for the products which maximize utility but minimize costs. The auction, therefore, offers this to the consumers since its minimum price tends to be lower than the prevailing market price. This applies to traditional, online, and eBay auction processes as similar rules and guidelines are used to regulate the markets.

Conclusion

The auction process empowers the buyers to contribute to price determinations since it offers the chance to determine the price they can willingly purchase the product. Although the seller fixes a secret reserve price below which the product cannot be sold, the process enhances the active participation of the bidders in setting up the best price for the commodity. The minimum bidding price is sometimes disclosed to the participants in order to guide their bidding process. However, in some cases, the seller can choose to retain it in order to have some special powers to adjust it when the need arises. Auction acknowledges the highest bidder as the winner of the bid during the auction process. Upon the highest bidder, the seller hammers down confirming the end of the bidding process. The closure of the bidding process grants the highest bidder the ownership right of that given product. However, the sale is completed if the highest bidder attains the secret reserve price, otherwise, the seller does not in any case hammer down the auction. Nevertheless, the seller cannot alter the secret price in excess of the prevailing market price. The minimum bid price, therefore, safeguards the consumer welfare at all times regardless of the auction method used.

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References

Fischer, S. & Rotemberg, J.J. (1994). NBER Macroeconomics Annual 1994. London, MIT Press. Web.

Groves, T., Radner, R. & Reiter, S. (1987). Information, incentives, and economic mechanisms: essays in honor of Leonid Hurwicz. Minneapolis, University of Minnesota Press. Web.

Hendershott, T. (2006). Economics and information systems. Bingley, Emerald Group Publishing. Web.

Katkar, R & Reiley, D.H. (2005). Public versus secret reserve prices in eBay auctions: Results form a pokemon field experience. Web.

Milgrom, P.R. (2004). Putting auction theory to work. London, Cambridge University Press. Web.

Ockenfels, A., Reiley, D. & Sadrieh, A. (2006). Online auctions. NBER Working Paper 12785. Web.

Paley, N. (2006). The manager’s guide to competitive marketing strategies. London, Thorogood Publishing. Web.

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BusinessEssay. (2022, August 12). The Value of Minimum Prices in Auctions. Retrieved from https://business-essay.com/the-value-of-minimum-prices-in-auctions/

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