Vsauce! Kevin here, and I’m auctioning off the ultra-rare
PlayStation 5: Jake Roper “Prepare to Cry” edition, which evokes the frustration and
heartbreak of Jake’s fruitless attempts at securing his very own PS5. With this edition, you’re buying countless
hours of entertainment -- and a monument to one man’s pain. I’m auctioning it using a system of sealed
bids -- the bidders submit their price and we determine a winner. I’ve got 4 bids… Ready? Okay bid number one... Hideo Kojima? MY GREAT FRIEND HIDEO KOJIMA WHO I MET FOR
9 SECONDS IN 2013? Even HE can’t get a PS5? Alright well, $400, that’s pretty undervalued
-- he must be a very patient and frugal man. The PS5 retails for $499, so if this bid wins,
Kojima is getting a serious deal. Alright, bid #2: BALLOON KEVIN!? You are not Real Kevin! How many times? I am Real Kevin. How did you even get in here? Well, Whatever. And what is your bid? $3? $3. Okay. Balloon Kevin is a scammer. What a stupid bid. But I guess maybe he thought lowballing was
worth a shot. Whatever. Ugh. Moving on... Bid #3: Oh, this bid is actually from Jake
himself, still desperately trying to get a PS5. $550? That, that’s fair. It’s a 10% premium on top of the going price,
which makes sense for something in such high demand. Smart bid -- good luck! Hopefully we can dry those Roper tears. And now to reveal the fourth and final bid. Drumroll please... $8,000!? WOW! That is.. THAT is a serious bid. Michael must really want this thing. Well, SOLD! For $8,000. THAT is absolutely what you would call a.. Pro. Gamer. Move. Dramatically outbidding everyone to secure
the win, and here’s something that you don’t realize is so genius about it. This isn’t a normal auction. No. This is a Vickrey auction! Which means the winner doesn’t pay the highest
bid. They pay the second highest bidder’s bid. In this case, that’d be Jake’s $550. Sorry Jake. You’re really gonna wanna stay hydrated
because those tears will continue to flow as Michael is playing his brand new PS5 after
only paying YOUR $550 bid. So, that’s that! And as always thanks for watching… w….wait… A really aggressive bid worked out this time,
yeah. But overbidding on a Vickrey auction is actually
a really, really bad idea -- and virtually no one realizes that the most popular auction
house in human history works this way. Here’s a question: WHAT ARE AUCTIONS? The discipline of auction theory within economics
is built on a handful of basic auction formats. You’re probably used to auctions that start
low and people bid back and forth until there’s only one bidder left. The highest bid wins -- that’s an English
auction, or an “open-bid ascending auction” if you wanna get TECHNICAL. You can also do auctions the other way, as
well. A Dutch auction starts at a price nobody would
pay and descends until the first person bids and thereby wins instantly. And there are two types of sealed bid auctions. In a normal sealed bid auction, everyone submits
their secret bid and the highest one wins -- the end. Then there’s the Vickrey Auction, a sealed
bid auction in which the highest bidder actually pays the second-highest bid. But why would you do it that way?! Why not just keep it simple? And how can such a tiny change in the rules
even make a difference? First, it’s important to note that we’re
dealing with an item with known value. There’s an established retail price for
the PS5, so we’ve got a pretty good sense of what it’s worth -- millions of people
have paid that price. Compare that to, say… a painting. I might think it’s a $100 painting. Painting Collector McGee, a person I just
made up, might think it’s a $25,000 painting. I don’t know. But.. What about if the item is like an oil field
somewhere and no one knows what’s really under the ground. That makes it tough to establish a value yourself,
but it makes it really hard to know what other people might be bidding. With a PS5, we’ve got a pretty good idea
of what other people might be thinking. So let’s say Jake figured he’d be up against
someone who might bid at least as much as the $550 he was willing to pay… but maybe
they’ll try to get a deal and hope that everyone else can’t afford it. He thinks they’ve got a bidding range of
$450 to $650, with an equal probability of submitting any bid within that range. So should he bid $550, so half the time he
wins, half the time he doesn’t, and when he loses he’s not really out anything? In a standard sealed bid auction format… No. If he bids over $550 and wins, he’s losing
value by paying more than he wanted to, so that’s out. But if he bids under $550 -- say, $530 -- he’ll
still win 40% of the time against the mystery bidder, and each time he wins he’s saving
$20. If the highest bid was over $550, he would
have lost anyway. The extra value he gains out of saving $20
4 times out of ten outweighs that one time he’d bid $530 and lose to a bid of $550. That’s called ‘bid shading,’ and it’s
what Nobel prize-winner William Vickrey solved in 1961 in “Counterspeculation, Auctions,
and Competitive Sealed Tenders.” Vickrey’s work on auctions included the
development of the Revenue Equivalence Theorem, which showed that if an auction satisfies
a handful of conditions, the revenue for the seller will be the same no matter what the
format -- and for all this, he found out he won the 1996 Nobel Prize in Economics just
3 days before he died. So what’s so great about Vickrey Auctions? By making the winner pay the second-highest
bid instead, that incentive to manipulate the bidding evaporated -- and it actually
started to pay to be as honest as possible. Vickrey ushered in an era of honest bidding
being the dominant strategy in an auction -- let’s go back to Jake. He wants to pay $550 for the PS5 because that’s
what it’s worth to him. If he commits to the pro gamer move of bidding
$8,000 just to guarantee that he’ll win the auction, the second highest bidder could
be any number lower than that. He could get stuck paying $600, $800, $4,000,
or more, especially if someone else is trying to use the same strategy. Inflating his bid not only doesn’t help,
but could put him in a really bad position. If Jake wants to try to save a little money,
he can still bid $550 -- because if he wins, he’s paying less than that anyway based
on whatever the next-highest bid is. He doesn’t have to engage in bid shading…
and if he does try to game the system, he’s susceptible to being outbid and losing. In a second-price auction, potential buyers
also have a much harder time colluding with each other to manipulate the price in their
favor, and sellers just don’t have enough information to successfully ‘plant’ bids
to drive up a price. In a Vickrey auction, Jake’s incentive to
go higher or lower than his true value is just… gone. $550 is his best bid. But it’s not just best for him: everyone
he’s bidding against has the same incentive to bid honestly, too. The same forces are at work for them, and
they know it, so why not just be honest? The seller knows no one’s trying to game
the system, either, and they’re gonna get the best price for their item. And guess what? This is pretty much how eBay works. Everyone submits their bid and the winner
pays just a tiny bit more than the second-highest bid. Vickrey had no way to know that almost 60
years after his paper, one single website on the internet would house nearly a billion
and a half auctions for everyday items worldwide -- and virtually everyone would be able to
use his bidding system from a device in their pockets. The 2020 Nobel prize in Economics went to
Robert B. Wilson and Paul Milgrom for their work advancing auction theory -- and we’ve
been thinking about a system where I have something, you want it, and we need to figure
out how to exchange it in a way that’s best for both of us for a long time. The Greek historian Herodotus wrote about
Babylonian auctions in 2,500 BC, and that's the most surprising thing here. In 4,500 years of thinking about auctions,
the mathematical development optimizing the activity of billions of people is really close
to just… being honest. And in the spirit of honesty... I’m actually not auctioning my PS5 because
I have Demon’s Souls to play! And as always -- thanks for watching.
