Friday, February 24, 2006
eBay
First, there is new research which suggests that people ignore shipping costs (i.e., fail to do simple addition).
eBay sellers can boost profits by setting a low opening bid price and charging higher shipping charges, according to recently published research by Haas Professor John Morgan.
Morgan and co-author Tanjim Hossain, an assistant professor at Hong Kong University of Science and Technology, held 80 auctions of new music CDs and Xbox video games to test how consumers respond to different price schemes. In the eBay study, they varied the opening bid price and shipping charges on identical CDs, ranging from Britney Spears to Nirvana, and video games, including Halo and NBA 2K2.
In theory, dividing a price into these two pieces should have little effect on overall demand for a good, the economics professors note. A perfectly informed and fully rational consumer will merely add together the two parts of a price to obtain the total out-of-pocket price for an item and then decide whether to buy and how much to bid based on this total price. But thatÂs not what happened in their eBay auctions. Instead, they found that lowering the opening bid price while raising shipping charges attracts earlier and more bidders and ultimately leads to higher revenues compared with doing the reverse. Those findings suggest consumers pay less attention or even completely overlook shipping costs when making bids, the professors conclude.
Second, eBay is a second price auction. That is, winning bidders don't pay their bid. They pay the price bid by the second highest bidder. One of the things that I was forced to prove during my first year of grad school is that the optimal strategy for bidders in a second price auction is to figure out how much the good is worth to you and bid that amount. People don't behave this way. They bid, and when someone outbids them, they bid again and again. This is weird. Steven Landsburg explores this phenomenon in more detail here.
As for why I don't bid crazy high, this is quite simple. Imagine that your true value of the good is 150. That is, at a price of 150 you are indifferent between obtaining the good or not. Economists argue that you should bid 150 in a second price auction. Why? Well, imagine that you bid 1000, someone else bids 175 and you win. You now have to pay 175, but only value it at 150, so you "lose" 25. Bidding more than your value puts you in a position to lose surplus. Same goes for under bidding. Imagine that you only bid 100, and lose to someone who bid 125. You would have been happy to pay 125 becuase you still would have gotten a surplus of 25 (150-125). 25 is greater than 0, so you made a mistake.
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