Dollar auction

I got nervous and panicky just reading about this game. I wonder if I could con some people into playing it.

Economics professors have a standard game they use to demonstrate how apparently rational decisions can create a disastrous result. They call it a “dollar auction.” The rules are simple. The professor offers a dollar for sale to the highest bidder, with only one wrinkle: the second-highest bidder has to pay up on their losing bid as well. Several students almost always get sucked in. The first bids a penny, looking to make 99 cents. The second bids 2 cents, the third 3 cents, and so on, each feeling they have a chance at something good on the cheap. The early stages are fun, and the bidders wonder what possessed the professor to be willing to lose some money.

The problem surfaces when the bidders get up close to a dollar. After 99 cents the last vestige of profitability disappears, but the bidding continues between the two highest players. They now realize that they stand to lose no matter what, but that they can still buffer their losses by winning the dollar. They just have to outlast the other player. Following this strategy, the two hapless students usually run the bid up several dollars, turning the apparent shot at easy money into a ghastly battle of spiraling disaster.

Theoretically, there is no stable outcome once the dynamic gets going. The only clear limit is the exhaustion of one of the player’s total funds. In the classroom, the auction generally ends with the grudging decision of one player to “irrationally” accept the larger loss and get out of the terrible spiral. Economists call the dollar auction pattern an irrational escalation of commitment. We might also call it the war in Iraq.

From here through here.

Is it ever rational to enter the game? What seems frightening is the aspect of losses — if you’re in the lead, any move by anyone else pushes you into the bad losing position of 2nd place.

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3 Responses to Dollar auction

  1. Anonymous says:

    What would happen if the rules were changed so that the winner had to pay nothing?

  2. Eric says:

    i’m definitely going to run this experiment in my Econ 1A sections in a couple weeks. :)

  3. Eric says:

    to answer #1: if winner pays nothing, bidding will just go to infinity…

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