Procuring Commodities: First Price Sealed Bid or English Auction?

Abstract

We use laboratory experiments to examine the relative performance of the English auction (EA) and the first price sealed bid auction (FPA) when procuring a commodity. The mean and variance of prices are lower in the FPA than in the EA. Bids and prices in EA agree with game theoretic predictions while they don't in the FPA. To resolve these deviations found in the FPA, we introduce a mixture model with three bidding rules: constant absolute mark-up, constant percentage mark-up, and strategic best response. A dynamic specification in which bidders can switch strategies as they gain experienced is estimated as a hidden Markov model. Initially about three quarters of the subjects are strategic bidders, but over time the number of strategic bidders falls to below sixty-five percent. There is a corresponding growth in those who use the constant absolute mark-up rule.

Keywords: Procurement auction, experiment, hidden Markov model, decision rule of thumbs