Auction Sale: Types, Rules, Relationship

  • Post last modified:19 January 2022
  • Reading time:14 mins read
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What is Auction Sale?

Auction Sale is a public sale where the goods are sold by the auctioneer as an agent of the seller to the highest bidder. In an auction sale, people are invited to compete for the purchase of goods put up on auction by successive offers of advancing sums. Such offers are called ‘bids’ and the persons making such bids are called ‘bidders’.

The highest bid constitutes the offer and the fall of the hammer or other customary announcement constitutes the acceptance of the offer by the auctioneer.

Types of Auctions

There are four main types of auctions when a single item is being sold (and many variants of these types):

  1. English Auctions
  2. Dutch Auctions
  3. First Price Sealed Bid Auctions
  4. Vickrey Auctions

English Auctions

Ascending-bid auctions are also called English auctions. These auctions are carried out interactively in real-time, with bidders present either physically or electronically. The seller gradually raises the price, bidders drop out until finally, only one bidder remains, and that bidder wins the object at this final price.

Oral auctions in which bidders shout out prices, or submit them electronically, are forms of ascending-bid auctions.

Dutch Auctions

Descending-bid auctions are also called Dutch auctions. This is also an interactive auction format, in which the seller gradually lowers the price from some high initial value until the first moment when some bidder accepts and pays the current price. These auctions are called Dutch auctions because flowers have long been sold in the Netherlands using this procedure.

First Price Sealed Bid Auctions

First-price sealed-bid auctions. In this kind of auction, bidders submit simultaneous “sealed bids” to the seller. The terminology comes from the original format for such auctions, in which bids were written down and provided in sealed envelopes to the seller, who would then open them all together. The highest bidder wins the object and pays the value of her bid.

Vickrey Auctions

Second-price sealed-bid auctions are also called Vickrey auctions. Bidders submit simultaneously sealed bids to the sellers; the highest bidder wins the object and pays the value of the second-highest bid.

These auctions are called Vickrey auctions in honour of William Vickrey, who wrote the first game-theoretic analysis of auctions (including the second-price auction [400]). Vickery won the Nobel Memorial Prize in Economics in 1996 for this body of work.

Relationship Between Auction Types

Let’s discussed the relationship between auction types:

  1. Descending-Bid and First-Price Auctions
  2. Ascending-Bid and Second-Price Auctions
  3. Comparing Auction Formats

Descending-Bid and First-Price Auctions

First, consider a descending-bid auction. Here, as the seller is lowering the price from its high initial starting point, no bidder says anything until finally someone actually accepts the bid and pays the current price. Bidders, therefore, learn nothing while the auction is running, other than the fact that no one has yet accepted the current price.

For each bidder i, there’s a first price bi at which she’ll be willing to break the silence and accept the item at price bi. So with this view, the process is equivalent to a sealed-bid first-price auction: this price bi plays the role of bidder i’s bid; the item goes to the bidder with the highest bid value, and this bidder pays the value of her bid in exchange for the item.

Ascending-Bid and Second-Price Auctions

Now let’s think about an ascending-bid auction, in which bidders gradually drop out as the seller steadily raises the price. The winner of the auction is the last bidder remaining, and she pays the price at which the second-to-last bidder drops out.

Suppose that you’re a bidder in such an auction; let’s consider how long you should stay in the auction before dropping out. First, does it ever make sense to stay in the auction after the price reaches your true value? No: by staying in, you either lose and get nothing, or else you win and have to pay more than your value for the item.

So this informal argument indicates that you should stay in an ascending-bid auction up to the exact moment at which the price reaches your true value. If we think of each bidder i’s “drop-out price” as her bid bi, this says that people should use their true values as their bids

Second, does it ever make sense to drop out before the price reaches your true value for the item? Again, no: if you drop out early (before your true value is reached), then you get nothing when by staying in you might win the item at a price below your true value.

Comparing Auction Formats

In the next two sections, we will consider the two main formats for sealed-bid auctions in more detail. Before doing this, it’s worth making two points. First, the discussion in this section shows that when we analyze bidder behaviour in sealed-bid auctions.

We’re also learning about their interactive analogues with the descending-bid auction as the analogue of the sealed-bid first-price auction, and the ascending-bid auction as the analogue of the sealed-bid second-price auction.

Second, a purely superficial comparison of the first-price and second-price sealed-bid auctions might suggest that the seller would get more money for the item if he ran a first-price auction: after all, he’ll get paid the highest bid rather than the second-highest bid. It may seem strange that in a second-price auction, the seller is intentionally undercharging the bidders.

But such reasoning ignores one of the main messages from our study of game theory — that when you make up rules to govern people’s behaviour, you have to assume that they’ll adapt their behaviour in light of the rules.

Here, the point is that bidders in a first-price auction will tend to bid lower than they do in a second-price auction, and in fact, this lowering of bids will tend to offset what would otherwise look like a difference in the size of the winning bid.

Rules of Auction Sales

Following are the rules of auction sales:

  • Where goods are put up for sale in separate lots, each lot will prima facie be deemed to be the subject matter of a separate contract of sale.

  • The sale is complete when the auctioneer announces its completion by the fall of hammer or in other customary manner i.e. saying ‘one’. ‘two’ and ‘three’ or going, going and gone etc. When a person bids, it is only an offer. It is deemed to be accepted by the fall of hammer, i.e. before its acceptance, it can be withdrawn by the bidder.

    Law which does not permit a bidder to retract his bid before it is accepted shall be invalid. It shall be against the law which provides that an offer can be rescinded before it is accepted.

Example: In an auction sale it was notified that bid once made shall not be withdrawn by the bidder. One the bidder was interested to withdraw the bid before the fall of the hammer. The bidder was entitled to withdraw his bid before it was accepted. The auction sale is complete when the bid has been accepted by the auctioneer. As such if the goods are damaged before completion of the auction sale, the loss will fall to the seller.

Example: X made a bid of Rs. 50000 for a costly glass showcase in an auction sale. The auctioneer while striking his hammer accidentally hit the glass showcase breaking it into pieces. Here the sale was not complete and as such the seller was to bear the loss.

  • A right to bid may be reserved expressly by or on behalf of the seller. Where such right is expressly so reserved, but not otherwise, the seller or any other person on his behalf may bid at the auction. Rainbow Vs. Hawkins (1904) 2 K.B. 322: In this case, the auctioneer by mistake accepted the bid for less than the reserve price. On finding out the mistake, the auctioneer refused to complete the sale. It was held that the buyer was bound by the reserve price of the goods.

  • Where the seller makes the use of pretended bidding to raise the price without expressly notifying about the same, the sale may be regarded as fraudulent by the buyer, who may avoid the contract. The persons employed by the seller to make pretended bidding are known by different names such as puffers, by-bidders etc.

  • Where the sale is not notified to be subject to a right to bid on behalf of the seller, it shall not be lawful for the seller to bid himself or to employ any person to bid at such sale, or for the auctioneer knowingly to take any bid from the seller or any such person; and any sale contravening this rule may be treated as fraudulent by the buyer.

  • The sale may be notified to be subject to a reserve or upset price. The reserve price is a price below which the auctioneer will not sell, and if by mistake, the auctioneer, knocks down the goods for less than the reserve price, no valid contract would come into existence. In such a case, the auctioneer can refuse to sell the goods to the highest bidder.

    Rainbow v. Hawkins (1904) 2 K.B. 322: In this case, the auctioneer by mistake knocked down the property for less than the reserve price. Subsequently, he refused to complete the sale. It was held that the buyer had no remedy against the auctioneer even when he was unaware what the reserve price was.

  • Where the sale is not to be subject to reserve price, the goods are to be sold to the highest bidder, whether the same bid be equivalent to the real value or not.

Consolidated Coffee Ltd. vs. Coffee Board AIR (1981) Sec 1621: In this case, the Supreme Court observed that:

  1. In an auction sale, the goods are generally sold to the highest bidder i.e., to the person who is ready to pay the highest price.
  2. The highest bid constitutes an offer to buy and the fall of the hammer or any other customary announcement constitutes an acceptance of the offer by the auctioneer.
  3. The auctioneer is not bound to accept the highest bid. He may reserve his right to refuse any bid or to accept a lower bid in preference to a higher bid.
  4. On the fall of the hammer or any other manner of customary announcement of acceptance, the contract of sale comes into existence. However, the ownership of the goods is not transferred to the buyer on the fall of the hammer etc. Only the contract of sale is completed.
  5. Before the completion of the sale (fall of hammer etc.) the bidder can retract (withdraw) his bid.

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