Internet Auctions And Their Economic Leverage

Internet Auctions and their

Economic leverage

Table of content:

1. Introduction

2. Internet auctions

2.1 Electronic marketplaces

2.2 The process of price determination

2.3 Impact on supply and demand

3. Benefits and disadvantages

3.1 The results for supplier and consumer surplus

3.2 Opportunities of fraud

4. Conclusion

5. References

6. Figures

1.Introduction

In recent years the availability of the internet has increased at a rapid pace and almost everyone in the western world has now access to the internet in some way. In accordance with the growing accessibility of the internet, the use of electronic market places, especially of internet auction platforms, has become more and more popular. Particularly small businesses and consumers started to engage in auctions on platforms like e-Bay and OnSale. e-Bay's company update (06. 2006) shows that they currently have 203 million registered users around the globe, which is a market share of 85 % (Alberta E-Future Centre, n.d.) and among those are thousands of non professional sellers making their living with sales on e-Bay. The questions arising from this new way of conducting business is, if it is efficient or not.

This paper will give an answer to this question taking e-Bay as a representative for the whole Internet auction industry. First it will define what electronic markets are and what position internet auctions have among those. Subsequently a brief description of how internet auctions work, what the typical auction rules are and how auctions fix prices will be given. Afterwards the impact on supply and demand and on welfare will be described. With reference to the impact on welfare a closer look at the risks of internet auctions will be given.

2 Internet Auctions

2.1 Electronic marketplaces

Electronic markets are "[...] with the help of information technology provided marketplaces. That is, the mechanism of exchanging goods and services according to the market forces between multiple suppliers and demanders" (Schmid, 1993). Meaning that they support least some stages of the transaction (Information search, negotiation and clearing) and sometimes the price determination. There are several types of electronic marketplaces which can be classified, in conformity with FÐ'hnrich (2003), in the following way:

Information oriented: no business transactions; no price determination; essentially link lists

Catalog oriented : no business transactions; price comparing mechanism; search

possibilities

Auction oriented : dynamic price determination; transaction support

Process oriented : transaction support; price determination

Here it can be shown that internet auction platforms are a special form of electronic marketplaces with its own features regarding the transaction and more important with regard to the price determination.

In general a market has three main functions, which Bakos (1998, p.1) identified as Matching buyers and sellers, facilitation of transaction and institutional infrastructure. "Matching buyers and sellers" is essentially the process in which buyer's demand is met by the sellers' product offerings. "Facilitating the transaction" and "the institutional infrastructure" are supportive attributes of a market making the exchange of goods or services possible and providing tools for the legal enforceability of the rights of consumers and suppliers. Internet auctions as opposed to the other forms of electronic marketplaces offer all of these functions, with some exceptions in the field of the legal enforceability. Therefore the use of them is very convenient for a wide range of people.

2.2 The process of price determination

"Most business transactions are conducted via one of the three mechanism: (1) posted price, (2) a negotiation process or (3) an auction." (Pinker et al., 2003, p.1458). The way in which prices are determined in an auction actually depends upon the set of auction rules being used and Pinker et al. referred to them as the "Auction Mechanism" and the "Bid Constraints".

The "Auction Mechanism" is basically the method in which the bidding takes place. There are several forms of these "Auction Mechanism", but the English, first price sealed bid , second price sealed bid and Dutch auctions are by far the most common used ones. In the case of internet auctions, especially on e-Bay, the English auction is the dominant auction type. Here the auctioneer establishes a starting price and the auction starts. Bidders are free to bid on the good or service and there are no constraints to the number of bids for the duration of the auction. When the auction ends the highest bid at that moment wins. The results of the auction including all bids are openly available.

"Bid constraints" are rules that influence the bidding in an auction and on e-Bay a couple of those bid constraints are available to the auctioneers. Minimum bids require participants to bid at least a certain amount defined by the auctioneer. If the auction ends before someone has bid this amount, the auctioneer is not required to sell the good or service. This minimum bid constraint reflects the reservation price of the auctioneer and is equal to the smallest monetary value the auctioneer may obtain. There are also buy-now prices, which as the name is already indicating are prices set by the auctioneer and are equivalent to a maximum bid. As soon as one consumer agrees to pay the buy-now price