While auctions may seem simple, successful participants need to have a firm understanding of strategies and terminology involved in the process. Both bidders and sellers who don't understand the basic terms associated with auctions can end up making errors that either cost them profits or cost them the item they want. The following sections contain key terms that auction participants should understand before they participate in an auction.
Two of the basic terms participants must understand are common value and private value. Both of these terms refer to how much bidders believe an auctioned item is worth. Common value, however, refers to worth determined by external factors, such as how much the item get be resold for in another marketplace. Private value, on the other hand, deals with worth determined by internal factors, such as how badly a particular bidder wants to own that item.
Two other terms related to bidder behavior are risk averse and risk neutral. Risk averse bidders are willing to increase their bids beyond the value they have placed on the item in order to win the auction while risk neutral bidders will only bid up to that value and then stop. Generally these two types of bidders will behave differently because of their two different perceptions of risk.
There are also many different types of auctions available. Discriminatory auctions, for instance, involve the selling of multiple items but the bids are all sealed. Winners will always pay the amount of their bid, even if each winners has bid a different price. There are many different types of discriminatory auctions. Uniform auctions also involve the auctioning off of multiple items with sealed bids, but all winners pay the highest losing price for their goods.
Auctions can also be first-price or second-price. Second-price auctions, like uniform auctions, require winners to pay the highest losing bid in order to purchase the item, instead of their actual bid. First-price auction, however, require the winning bidder to pay the exact amount that the bidder has bid for a single item.
Additionally, auctions can be considered single-shot or repeated. One-shot auctions take place during a single, specific auction period. When that period ends, the auction is over. With repeated auctions, the bidding can continue through multiple trading periods and can have complex rules that govern how the participants behave and bid from one period to another.
Finally, auctions are classified as either one-sided or two-sided. In two-sided auctions both bids and asks are allowed. Bids are the amounts offered by the potential buyers to purchase the item. Asks are prices offered by the seller. A transaction is created when the bid and ask prices match. One-sided auctions, however, only allows bids and the auction goes to the highest bidder.
Besides terminology that helps individuals determine the rules of their specific auction, there are other terms that apply to all auctions. For example, “knocked down” means that the item has been sold. Reserve price, another of these terms, is a minimum price set by the seller. If none of the bids reach this price, then the seller does not have to accept the highest bid. Bidding can either start at or below the reserve price. The reserve price is not generally known by auction participants; only the seller.
A few other terms that are sometimes used during auction discussions are the “fast knock” and the “jump bid.” A “fast knock” is not an option in traditional on line auctions because it occurs when the auctioneer introduces an item, the bidding starts at a unusually low price, and then the auctioneer accepts the first bid as the winner. This strategy is often used when bidders seem sluggish and can get people's attention. A “jump bid” is common in both on- and off-line auctions. Jump bids are increases in the current bid amount in an unusually large increment. In online auctions that use proxy bidding, the increase may not be viewable by all bidders because the jump bidder's maximum price is sealed.
Finally, auctions do have some disadvantages. One is the Winner's Curse which is occurs when a winning bidder ends up paying more for an item than what it is valued at. Another disadvantage is unethical behavior. Rings, which are groups of bidders who agree not to outbid each other, are a problem in almost all types of auctions. This is a form of collusion.