The £1 Coin Auction – Money For Nothing

We in Behavioural Economics use experiments to discover how people think. The way you design an experiment matters. Here’s a fun illustration: the £1 coin auction.

http://i.telegraph.co.uk/multimedia/archive/01380/PoundCoins_1380993c.jpg

1) Traditional Auction

This will be very familiar to you, it’s the most common type of auction; used in antique and art auctions worldwide. 

The bidding starts at 1p and people make higher bids if they wish. The winner wins the £1 coin and pays the winning bid. For example, 1p might be followed a bid of 2p, which might be followed by 3p etc etc. 

Obviously, the highest bid anyone would be prepared to bid will be 99p (or £1 if someone doesn’t mind making no gain).

2) New Auction Design

This time I will introduce a new rule; the winner wins the £1 coin and pays their winning bid, AND the person who bid the second highest amount pays their highest bid despite not winning anything.

Wanna guess what the highest bid is likely to be?

It depends on how many people bid. If only one person bids then obviously they win the £1 coin and they pay their only bid. If, however, another person enters the auction it starts to get interesting...

If the opening bid was 1p, the second bid would have to be at least 2p, and so on. Eventually the highest bid would reach 99p. Because the second highest bidder will have to pay their bid anyway, it would be worth bidding £1. 

Then, the person who bid 99p would have an interesting decision. If they don’t bid any higher and accept defeat they will lose 99p for no gain. If they bid 101p for the £1 coin then they will still have a net loss, but only 1p. Thus they will bid 101p.

You can probably see where this is going now. There is no logical maximum price, as it always slightly less bad to bid slightly higher. If I actually ran this experiment for real I could make millions (or at least the price would go up until someone decided enough was enough).

In conclusion, experiment design matters. 

More importantly, you now have a cast iron way of scamming your mates. £1 coin auction anyone??

Relevant listening:

Money For Nothing by Dire Straights