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York economist bids to change the way auctions work

Posted on 4 July 2014

A University of York economist has developed a new approach to auctions which could help to transform the way multiple goods are sold.

Professor Zaifu Yang of the Department of Economics and Related Studies, at York, working with Professor Ning Sun of the Shanghai University of Finance and Economics, made the breakthrough in auction design. 

Detailed in a paper in the Journal of Political Economy, they propose an alternative to English and Dutch auctions, traditionally the most common market mechanisms for allocating goods and services. The English auction, based on rising bids, is most often used to sell durable goods such as artworks. The Dutch auction, based on a descending price, is typically used to sell perishable goods such as flowers and fish. 

In the last two decades, auctions for selling multiple goods have become increasingly popular. Such auctions have been extensively used by governments to sell spectrum licenses, to procure goods and services, and to privatize state companies, as well as by firms to sell virtually all kinds of commodities on the Internet.

But selling complementary goods is recognized as a major challenge in auction design.  Goods exhibit complementarity or synergy if losing some of them will dramatically reduce the value of the remaining goods. The conventional practice of handling complementary goods is to sell them as one package, often resulting in inefficient outcomes.

Professor Yang and Professor Sun propose an efficient and incentive compatible dynamic auction mechanism to tackle the problem. Their dynamic auction works roughly as follows: The seller has reserve prices. The auctioneer announces a current price for every bundle of goods and a supply set of goods, every bidder responds with a set of goods demanded at these prices, and the auctioneer adjusts prices. 

They prove that even if bidders can exercise their market power strategically, the auction always induces bidders to bid truthfully as price-takers, yielding an efficient outcome. This auction can therefore prevent strategic manipulation by any bidder and at the same time achieve market efficiency.

Professor Yang says: “Besides its theoretical significance, this approach may also have far-reaching implications for practical auction design. Firstly it deals with a general and practical market model in which bidders possess payoff-relevant critical private information and may have incentives to economize on such information; secondly it has taken the complex nature of rational and strategic economic agents into account.

“For instance, bidders are reluctant to reveal their private values, prefer simple, robust and transparent trading rules, and are accustomed to a competitive price system rather than a non-price system. Moreover, this auction is robust against bidders' regret and independent of the probability distribution of their values, while the conditions are extremely general and simple.”

It is believed that this new approach has opened a new avenue towards coping with practical and complex resource allocation problems.

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