When an item that wins an auction turns out to be overvalued over time, this is known as the winner’s curse. If buyers don’t behave rationally, auctions can lead to unexpected losses, making it difficult to form efficient prices.
In one auction, John Lennon’s guitar was sold for more than 10,000 times its purchase price. The guitar was not just a musical instrument, but an important piece of music history and an object of symbolic value to his fans, which made it even more valuable. The winner of the auction paid the price for the joy he could derive from the item, and the seller was probably happy with the high price.
However, if the winning bidder gets tired of Lennon’s guitar after a while, he or she will soon realize that the item is overvalued. Due to the emotionally driven nature of auctions, the passion and excitement of the moment can often drive prices above their true value. While today’s winning bid may seem efficient, it may not be a reasonable price in the long run. At the end of the day, the price determined at an auction reflects the value of the moment, but it’s not necessarily the value that will last over time.
For example, consider the process of auctioning off the right to mine crude oil. Given that the reserves and commercial viability of crude oil cannot be accurately predicted, let’s say Company A uses a scientific method to estimate the most accurate value, but that doesn’t guarantee that it will be awarded the rights at auction. Rather, Company B, the company with the most optimistic overestimation, wins the mining rights. In this case, the winner of the mining rights is actually a loser in the marketplace. This is a crucial decision that can have a huge impact on the future of the company, not just the commercial value of the resource. This phenomenon is known as the winner’s curse. It’s the result of being too bold in valuing an uncertain future.
If the buyer is rational, he or she will set the price to suit his or her intended use. The result is an efficient exchange at the right price. In economics, the term “efficient exchange” refers to an exchange at a price at which all parties to the transaction do not lose money. For example, if the cost of an item, including a reasonable profit margin, is 10,000 won, and you sell it for 20,000 won or 8,000 won, someone will take a loss, which is inefficient. However, if you sell it for exactly 10,000 won, it’s an efficient transaction because both parties are satisfied with the exchange. No other price other than 10,000 won can satisfy both parties. This is why monopoly prices are inefficient and competitive prices are efficient.
An auction is a process that determines the efficient price. If all buyers in an auction are rational, there is no winner’s curse. Especially when there is good information about future value, or when there are many of the same type of goods being traded, rational prices are determined. This rationality plays an important role not only in auctions, but also in financial markets, which is why efficient prices can be established through auctions in the stock market. However, if someone behaves irrationally, auctions can have unexpected results. Just as there are bubbles in stock prices, the auction price can go too high. So the winner has to bear the pain and curse of irrational decision-making.
