CHRISTIAN

YENKO ECON 310-2, PROF. JEFF ELY 11/21/12 1. PROBLEM SET 7 , > ! > ! a. = 1, ! > ! > ! 2, ! > ! > ! b. i. Given that the mechanism abides by Vickrey auction rules, this mechanism does achieve the utilitarian allocation rule, since Vickrey auctions are efficient. The good will go to the person who values it most, including the seller (i.e. no trade) if the cat is the person who values it most. ii. There is a profile for which the VCG mechanism causes a deficit. One such profile is when ! + ! > , but ! < and ! < . We see that through the VCG mechanism, the hat should be purchased, but the sum of contribution from both buyers is less than the cost to the cat. iii. The mechanism is indeed incentive compatible it is a dominant strategy for individuals to announce truthfully their values. In the case where buyer 1 wins the auction, or ! > , ! > ! , ! > , we see that if buyer 1 overbids, he will still win the auction and pay the same price ! . If he underbids, then he will either pay the same value and receive equal payoff, or if he bids under buyer 2, he will receive utility of 0. The same is true for buyer 2. If buyer 2 overbids, he/she will win but pay more than his/her utility, resulting in negative utility, and if buyer 2 underbids he/she will still receive a value of 0. If it is the case where ! > , ! > ! , > ! , then we see that buyer 1 will win and pay the reserve price. If he overbids, he will still pay the reserve price, and if he underbids, he will either receive equal payoff or not receive the good at all (utility of 0). The same is true for buyer 2. If buyer 2 under or overbids, he/she will still lose the auction and receive 0 utility. Finally, if it is the case where > ! > ! > ! > ! , then the item is allocated to the cat, and if either buyer 1 or buyer 2 overbids to receive the item, he/she will receive negative utility (a lower payoff). If he/she underbids, there will be no effect on the outcome of the auction.

CHRISTIAN YENKO ECON 310-2, PROF. JEFF ELY 11/21/12 2. PROBLEM SET 7 a. It is a dominant strategy, since the bidders final cost is not determined by what he/she says; rather, it is determined by an outside factor. Repeating the same reasoning found in question 1, we see that if a bidder bids greater than his true value, he will still pay the third highest bid given that the third highest bid is greater than reserve price r2. If he bids less than his true value, he will pay either the same amount or nothing and receive a value of 0. If his bid is not the highest or second highest bid, he will receive a value of 0 if he underbids or bids his true value either way, and he will receive negative value if he overbids. b. We would set reserve price ! equal to value ! , so that the lowest possible value to obtain from selling the last book is ! . Value ! can be set to whichever price below ! . c. A profit maximizing seller would never set ! < ! , since he can obtain greater utility if he keeps one book and sells the other, as opposed to selling both books for value ! or third highest bid. d. Given that ! = 0, we see that the seller would prefer to sell both books at whatever cost, as opposed to keeping one book and selling the other for value 0. This is because if both bids are not above r2, then we will only sell one book and at a price r1=0. We therefore want to set the price at which both goods are sold at to greater than our value for receiving one book. If r2 were less than v0, that would mean that we would receive less value if we sold two books, than if we had sold one book and kept the other.