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Optimal bidding strategies

Chapter 16-4
Your company is bidding for a service contract in a first-price, sealed-bid auction. You value the contract at $12 million. You believe the distribution of bids will be uniform, with a high value of $16 million and a low value of $3 million. What is your optimal bidding strategy with

a. 5 bidders?
b. 10 bidders?
c. 20 bidders?

Chapter 17-2
Suppose the typical Florida resident has a wealth of $500,000, of which his home is worth $100,000. Unfortunately, he lives in hurricane alley, and it is believed there is a house (i.e., a loss of $100,000). However, it is possible to retrofit the house with various protective devices (shutters, roof bolts, etc.) for a cost of $2,000. This will reduce the size of loss from a 10 percent chance of loss of $100,000 to a 5 percent chance of a loss of $50,000. The homeowner must decide whether to retrofit and thereby reduce the expected loss. The problem for the insurance company is that it does not know whether the retrofit will be chosen and therefore cannot quote a premium, which is conditional on the policyholder choosing this action. Nevertheless, the insurance company offers the following two policies from which the homeowner can choose: (1) The premium for insurance covering total loss is $12,000; 0r (2) The premium for insurance covering only 50 percent of loss is $1,500. The typical homeowner has a utility function equal to the square root of wealth. Will the homeowner retrofit and which insurance policy will the homeowner buy? Will the insurance company make a profit (on average) given the homeowners choice?

Book: Managerial Economics; Theory, Applications, and Cases
Author: Mansfield and etc. Sixth Edition

Solution Preview

Chapter 16-4
Your company is bidding for a service contract in a first-price, sealed-bid auction. You value the contract at $12 million. You believe the distribution of bids will be uniform, with a high value of $16 million and a low value of $3 million. What is your optimal bidding strategy with

a. 5 bidders?
b. 10 bidders?
c. 20 bidders?

This situation requries that you shade your bid. This will be an estimate of the next highest If there are 5 bidders, you will shade your bid by 1/5, for a bid of $12 million minus 2.4 million, or 9.6 million. With ten bidders, you would shade your bid by 1/10, or 1.2 million, for a bid of $10.8 million. For 20 bidders, your bid would increase to $11.4 million. As more bidders enter the auction, the probability of a bid that's near your own increases, necessitating the higher bid.

Chapter 17-2
Suppose the typical Florida resident has a wealth of $500,000, of ...

Solution Summary

Risk aversion and expected utility; bidding strategies based on the number of bidders

$2.19