Rethinking Markets

When the bidding for the $10 reached $20, I got a little edgy. When it reached $40, I stopped the auction.

Today is the first day of class, and in recent iterations, I have done an exercise where I auction off a real $10 bill. The auction has a lore at Kellogg, and it has been written up in a management education journal. The rules are as follows:

1. Bidding starts at $.50 and proceeds in $.50 increments. And yes, this is for real money.
2. No jump bidding.
3. The auctioneer will give all bidders a fair warning before the auction ends.
4. Cartels and collusion among bidders are strictly prohibited. This means no communication, verbal or nonverbal, is allowed.
5. The highest bidder pays what they bid and receives $10.
6. The second highest bidder pays what they bid.

Yes, I tell them, this is for real money. Instead of a $20 at $1 increments (as in the article), I use a $10 at $.50 increments.

A bit about the composition of my class. There are 25 or so students, in a 9AM class on the first day of the semester. Between 1/3 and 1/2 are Columbia students, and about 1/5 of them are men. These numbers are pretty average for a lecture class at Barnard. These are undergraduates, and although some know each other, they are generally strangers. Before the auction began, I introduced myself, and I had them turn and introduce themselves to their neighbors.

The first auction proceeded, with quite a few bids. As the bids got closer to $10, fewer students bid, and one student who had not bid at all up through $8, $8.50, $9, $9.50 jumped in to bid ‘$10!’. When the next highest bidder bid $10.50, his face kind of fell. The first auction ended up going for $11.50, with the winner paying $11.50 for the $10 bill, and the second highest bidder paying $11.

Then I brought out a second $10. Again, a lively set of bidder engaged with the bidding up to around $8, when a couple of newer bidders joined. This time, they pushed through $10 pretty quickly. A woman in the front row was bidding the ‘evens’ ($10, $11, $12), while a man in the back row was bidding the .50s ($10.50, etc.). When the bidding hit $15, a student next to the back-row man dropped his jaw and started staring at him. At $20, the woman in the front muttered ‘why won’t he stop?’. The class reaction went from laughing (at $10-15), to incredulous (at $20), to a version of what I can only describe as sullen (at $35).

When the auction showed no sign of stopping at $40, like the author of the paper, I stopped the auction, and allowed the students to do a closed-bid, uniform-price auction, or Vickrey auction. The final bids for the $10 were $49, and $51.00. The winner paid $49 for the $10, and the second-highest bidder paid $48.50.

Yes, I took (or am taking, as one of the students asked to pay in installments) the money. I am using it for a charity/class project/treats to be named later. In the article, where the author conducted the experiment at Kellogg management school, with $20 and a group of students both more aggressive and more cash-rich than my undergrads, one auction went up to almost $2000. Yep. $2000.

Why does this work, and what is the value of it for my Sociology of US Economic Life class? It works because the rules of this auction set up conflicting sets of incentives – it facilitates a shift from ‘getting a bargain’ to ‘avoiding a loss’ quickly and easily. The reactions from the students were really interesting as well. One said that at some point, if you’re going to lose a ton of dough, you may as well at least win the $10. Another complained that when the price began to get high enough, the difference between first and second start to get smaller, and it becomes ‘irrational’ for players to keep bidding. I pointed out that it was irrational at $11.

In fact, my point in using the exercise (the management school uses it to demonstrate the challenges of commitment, loss aversion, setting limits and expectations before acting, etc.) is to demonstrate that while markets may work as they are ‘supposed to’, the underlying rules matter a huge amount. The devil really is in the details. And just calling something a ‘market’ does not make it efficient, even if it looks generally market-like. This is not inconsistent with some variants of institutional economics of course, and I’m happy to say so – despite some caricatures, not all economic sociologists reflexively bash economists. What I would say, however, is that markets are fundamentally social constructions, and when something is a social construction, you better be clear on the hows before you go ahead and assume it works.

All in all, a pretty intense and hopefully interesting first day of class.