The Art of the Bid: Behavioural Economics in Auctions

Image credit: South China Morning Post

You might picture fast-talking auctioneers, frantic eBay bids, or high-stakes art sales when you think of auctions. But what most people don’t realise is that auctions are a playground for behavioural economics, where psychology, strategy, and game theory intersect. Why do some bidders overpay? Why do others hold back until the last second? The answers lie in how human behaviour influences, and is influenced by, different auction formats. 

To put it simply, auction theory tells us that bidding is far more than just offering the highest price; it’s a high-stakes game of incomplete information and strategic interaction. Unlike traditional markets, auctions force participants to make decisions without knowing others’ true valuations. For example, in auctions where the item’s value is uncertain but common to all bidders, known as common value, the winning bidder may overpay because they tend to overestimate the item’s true worth relative to others. This  is called the Winner’s Curse. However, in private value auctions, where each bidder’s valuation is independent, the winner’s curse is less relevant, and overpayment depends more on bidder strategy and information. 

But theory doesn’t always predict reality: behavioural factors and deviations from assumptions often cause auction design to influence both bidder behaviour and outcomes. Quirks like overbidding (driven by ego or adrenaline), herd mentality (jumping in because others are), and sniping (last-second bids to avoid price wars) routinely warp results. Auctions aren’t just about who pays the most and who plays the game best. Take anchoring, for example, that starting bid of $5000 for a vintage watch isn’t just a number, it’s a mental magnet, dragging perceptions of value toward it, even if the watch is really valued at $3000. Then there’s herding, the auction equivalent of FOMO. When bids pile up, our mind tells us, "If everyone wants it, I must be missing something!", even for a questionable meme coin or a rare Labubu. Let’s not forget about overconfidence: "I’ve done my research, I can outplay these casual bidders!".

While auctions present themselves as transparent market mechanisms, they are vulnerable to several forms of strategic manipulation that distort pricing and undermine fairness. These practices demonstrate the intricate relationship between market design and bidder psychology in competitive auctions. A persistent issue is shill bidding, where sellers or affiliated parties submit fraudulent bids to inflate prices artificially. This issue is especially prevalent in online marketplaces and certain live auctions, where bidder anonymity complicates detection. The Federal Trade Commission has prosecuted numerous cases where sellers used secondary accounts to manipulate final prices, leaving legitimate bidders paying 20-30% premiums above true market value. 

More sophisticated is bidder collusion, where competing buyers coordinate to suppress prices. The 1990s price-fixing scandal between Sotheby's and Christie's demonstrated how even elite auction houses can engage in anti-competitive behaviour. Contemporary research shows similar patterns in procurement auctions, where contractors sometimes establish bid-rotation schemes or complementary bidding arrangements to allocate contracts artificially. 

Auctioneers also employ carefully honed psychological tactics. Theatrical pauses, deliberate misdirection ("I have a bid in the room that I don't see"), and fabricated bids (known as "chandelier bids" in the trade) create urgency and competition. Some research suggests that auctioneers’ psychological tactics, such as strategic pauses and misdirection, can exploit bidders’ loss aversion, increasing their willingness to bid beyond initial plans. 

So, how is auction theory actually used in real life? It is often coupled with mechanism design, which studies how firms and institutions can design optimal outcomes despite self-interest and incomplete information. One of its most significant applications is in government spectrum auctions, where the simultaneous ascending-bid format has revolutionised telecommunications. This design prevents collusion through activity rules, allows package bidding for complementary spectrum blocks, and has generated over $200 billion in government revenue worldwide. 

Similarly, the 2016–2017 FCC incentive auction repurposed broadcast TV spectrum for mobile broadband using a novel reverse-auction mechanism, showcasing how auction theory adapts to evolving policy goals. The principles of auction theory also underpin the $600 billion digital advertising industry, where real-time bidding (RTB) auctions occur at staggering scale. Each ad impression is sold via second-price sealed-bid auctions, with algorithms placing bids based on user data in milliseconds. Innovations such as header bidding have increased competition among advertisers by allowing multiple demand sources to bid simultaneously, thereby reducing information asymmetry and improving publisher revenues. Platforms like Google AdSense facilitate billions of real-time bidding auctions daily, often using second-price or first-price auction formats optimised through auction theory and algorithmic design.

Beyond telecommunications and advertising, auction theory shapes electricity markets, where multi-unit clock auctions match variable energy supply with demand in real time. These auctions incorporate complex constraints like transmission capacity and generator ramp rates, ensuring grid stability while minimising costs. From public resources to digital marketplaces, auction theory provides the framework for efficient, strategic, and fair allocations, proving that what begins as abstract game theory often ends as the invisible hand guiding critical economic transactions.

Next time you find yourself caught up in the thrill of an auction, whether you're eyeing a vintage vinyl, battling for a dream home, or watching the drama unfold, take a moment to appreciate the hidden mechanisms beneath the surface. From billion-dollar spectrum auctions to your neighbour's frantic eBay showdown, every gavel strike is a little lesson in human nature. We think we're bidding on objects, instead, we're revealing ourselves, our strategies, our momentary lapses, and that irresistible urge to win when we know we probably shouldn't. After all, the most fascinating thing up for auction isn't the item on the block, it's us.