Profit maximizing strategy is bidding half of your valuation

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Reference no: EM131250820

You are bidding against one other bidder in a first-price sealed-bid auction with private values. You believe that the other bidder's valuation is equally likely to lie anywhere in the interval between $0 and $500. Your own valuation is $200. Suppose you expect your rival to submit a bid that is exactly one half of its valuation. Thus, you believe that your rival's bids are equally likely to fall anywhere between 0 and $250. Given this, if you submit a bid of Q, the probability that you win the auction is the probability that your bid Q will exceed your rival's bid. It turns out that this probability is equal to Q/250. (Don't worry about where this formula comes from, but you probably should plug in several different values of Q to convince yourself that this makes sense.) Your profit from winning the auction is profit = (200 - bid) × probability of winning. Show that your profit maximizing strategy is bidding half of your valuation.

Reference no: EM131250820

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