The Dollar Auction

The dollar auction is a game designed by economist Martin Shubik to illustrate a paradox brought about by traditional rational choice theory (paraphrased from this short Wikipedia article). The game works like this:

Auctioneer auctions off $100, with a starting price of $1. The catch: second highest bidder also has to pay, so if the winning bid is $50, and the second highest bid is $40, the auctioneer earns $90.

Bidders start bidding; $5 turns to $10 turns to $20 turns to $50. At first, the bidders are all enthusiastic about the prospect of paying a small sum to win the $100 jackpot. As the bids near $100, however, bidders begin dropping out, to avoid placing the second highest bid and losing the entire sum.

At some point, all bidders drop out, save for Tim and Joey. Tim’s bid is $95, and Joey’s is $90. Joey doesn’t want to lose his $90, so he bids $100, hoping to at least break even. Tim, however, has already staked $95, so he ups the ante and bids $105 — better lose $5 than $95! At this point, both Tim and Joey are in the black, and the crafty auctioneer is gleefully smacking his lips.

Isn’t this great?

An anecdote: when I demonstrated the paradox to my wife, she deftly started off with a bid of $99. No point to even bid against her then, and the bid is profitable!

The paper that describes the paradox is just 3 pages long. Link.

If you, like me, found this paradox eerily satisfying, I think you’ll enjoy my newsletter. I try to keep all the boring, mainstream stuff out, and all the quirky, rebel stuff in. Let’s be friends.