Consider Rick, who found a rare coin listed on an online auction website. The auction is to last two weeks. Rick is very familiar with coin collecting and has a very good idea of the coin’s value. He places a bid based upon the value he believes the coin holds when he discovers the auction, and is satisfied because his bid is the highest thus far. He then waits, checking the auction site daily to see if his bid is still the top. One day before the auction is to close, he notices that someone has outbid him by at least $10. Rick quickly responds by upping his bid by $20, only to discover that he is still being outbid. Thus he follows up with another increase of $30, obtaining the top bid and winning the coin. Rick is very satisfied to have won the auction, and he doesn’t seem to be bothered by paying almost $50 more for the coin than he thought it was worth.
With the advent of online auctions, personal experience with bidding and auction behavior is much more prevalent than it once was. Most who have participated in online auctions can attest to a certain level of gaming and scheming by auction participants. Students have suggested what they consider to be optimal strategies. For example, one suggests not to bid until the very end of the auction so that it is difficult for your competitors to react to your bid and thereby win the object of the auction. In almost all cases, the strategies suggested the importance of tricking or taking other bidders by surprise with your own actions or strategy. How should one best respond to the actions of others in an auction? What sorts of psychological biases govern individual behavior in an auction setting? This chapter describes the regular behaviors found in auctions and their implications for strategy, marketing, and procurement. When the behavior of one person can affect the outcomes of others and vice versa, we say that the people are engaged in a game. Economists generally use a game-theory model to predict or describe behavior in games. This chapter builds on the basic elements of game theory, incorporating behavioral heuristics to describe deviations from the predictions of game-theory approaches.