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This section looks at different forms of auctions.

Different types of auctions have

different bidding behaviors. How a bidder will behave in an auction depends on the
reason with which the bidder is participating in the auction in the first place. One reason
for participating in an auction is that the bidder wishes to aquire the auctioned good for
personal consumption. One can consider a painting being auctioned and a buyer
bidding on it for personal use. In this situation, the bidder estimates his personal
consumption value of the item, and no one other than the bidder knows what that value
is. It is probably useful to note that even the seller does not know the values that the
bidders place on the auctioned item, since if he did he would just set the price equal to
the highest valuation.

The other reason for participating in an auction is to resell the item or use it for
commercial use. In such a situation the bidder's valuation of the auctioned item is
determined by his estimate of the future resale value of the item. So the item is actually
worth the same to all, however no one actually knows what that common value is. Think
of business houses trying buy a piece of land to aquire mineral rights. Each has
different information and different estimates of the future value of this land and
consequently would bid differently for it.

William Vickrey (1961) modeled four different types of single unit auctions:

English auction - This is the most familiar form of an auction; it is also known as
an open outcry or an ascending price auction. The type of auction is commonly
used to sell wine, art, antiques, cattle, tobacco, and many other goods.

Dutch auction - In the Netherlands, this form is used to sell produce and flowers,
and hence the name. This is also known as a descending price auction. In
Zamibia they use this auction to sell fish. The bidding starts at an a very high
price and is progressively lowered until a buyer claims the item.

First-price sealed-bid auction - The main distinguishing feature of this auction as

the name suggests is that the bids of individual bidders are sealed and not
known to all, and thus hidden from all except the bidder and the seller. In a
buyer-bid auction, the highest bidder buys the item and pays the amount of his
bid. In a seller-bid auction, the lowest bidder sells the item and is paid the
amount of her bid. This form of auction is used for construction contracting, some
military procurement and private-firm procurement, refinancing credit, foreign
exchange, and many other goods.

Second-price sealed-bid auction - Also known as the single-unit Vickrey auction.

In a buyer-bid auction, the highest bidder buys the item and pays the amount of
the second highest bid. In a seller-bid auction, the lowest bidder sells the item
and is paid the amount of the second lowest bid.

Signaling: The model

To illustrate his argument, Spence imagines, for simplicity, two productively distinct
groups in a population facing one employer. The signal under consideration is
education, measured by an index y and is subject to individual choice. Education costs
are both monetary and psychic. The data can be summarized as:

Data of the Model

Group Marginal Product Proportion of population Cost of education level y

I 1 y

II 2 y/2

Suppose that the employer believes that there is a level of education y* below which
productivity is 1 and above which productivity is 2. His offered wage schedule W(y) will

Working with these hypotheses Spence shows that:

1. There is no rational reason for someone choosing a different level of education
from 0 or y*.
2. Group I sets y=0 if 1>2-y*, that is if the return for not investing in education is
higher than investing in education.
3. Group II sets y=y* if 2-y*/2>1, that is the return for investing in education is higher
than not investing in education.
4. Therefore, putting the previous two inequalities together, if 1<y*<2, then the
employer initial beliefs are confirmed.
5. There are infinite equilibrium values of y* belonging to the interval [1,2], but they
are not equivalent from the welfare point of view. The higher y* the worse off is
Group II, while Group I is unaffected.
6. If no signaling takes place each person is paid his unconditional expected
marginal product . Therefore, Group I is worse off when signaling is present.
In conclusion, even if education has no real contribution to the marginal product of
the worker, the combination of the beliefs of the employer and the presence of
signaling transforms the education level y* in a prerequisite for the higher paying
job. It may appear to an external observer that education has raised the marginal
product of labor, without this necessarily being true.

The Bad Drives out the Good

Posted on October 19, 2011
In economics, there is a saying that bad money will drive out good money,
which is referred to as Greshams Law. It can be easily understood by
thinking about how currency may have been used in the Middle Ages. Think
of gold or silver coins; well use gold in our example. When a person wanted
to pay $50, he would use $50 worth of gold bullion, which was shaped into a
$50 coin. But an enterprising goldsmith had the idea to hollow out the coins,
replace the gold with lead, and still use a $50 coin to buy $50 worth of
goods. He will then hoard the real gold. As soon as people realise that some
coins are gold, while others are gold-plated lead, they will no longer pay with
pure gold coins. Those will be hoarded or melted down, while gold-plated
coins will be used for payment and stay in circulation.

We can see that bad money drives out the good because people keep what
they value, and trade what they can. In this case, what people value is gold,
for its inherent value. But besides money, people also value time and energy,
skill and effort. This leads me to propose that the bad always drives out the
good in any enterprise, including in management and governance. This goes
contrary to Adam Smiths idea of the invisible hand, where each person,
working for their own self-interest, inadvertently furthers the good of society.

In management, a part of the idea that the bad drives out the good is the
Peter Principle. The principle was developed in public schools in Canada, and
it can still be seen at work. It describes the situation where good teachers
are promoted to principal. This leaves the mediocre and poor teachers
behind, teaching. Good principals are promoted to superintendent, leaving
behind the mediocre and poor principals. Good superintendents are
promoted to the district administration, leaving behind the mediocre and
poor ones. In the case of each individual, he or she is promoted to their level
of incompetence. Obviously, hierarchies arent sufficiently wide to promote
everyone to their level of incompetence, so some positions will continue to
be competently staffed. It does explain, though, why middle management is
often incompetent.

There are more insidious reasons that bad management drives out good
management. One reason is the cost. If five talented managers can very
effectively run an organization, three mediocre managers can passably run
an organization for far less money. Further, if a manager is tasked with
supervising a department, but without producing any real measurables
except the work of others, a very human manager will soon find the least
amount of effort it is possible to expend; that is to say, people are lazy.
Certainly, harder work could translate into intangibles such as team spirit,
morale or the ability to inspire collaboration, but the managers job doesnt
normally depend on any of these things, only that the work continue to get
done. In this way, laziness drives out productivity, and not just in managers.
In fact, people who pride themselves on their productivity are likely to
transfer to a different department, or change jobs to a company that still
values productivity.

People will also leave a company due to the atmosphere. Imagine a

department with two middle managers. One is kind, while the other is mean-
spirited. It might not actually take any imagination, since most people have
worked with a mean person before. Is that offending person likely to leave
the company because of bullying or a negative work environment? Its far
more likely that the kind manager will finally tire of the poisoned atmosphere
and leave. The same would likely be true in the case of
dishonesty, commandeering or politicking. Nice guys finish last, by taking
themselves out of the competition and going somewhere they feel valued.

Bad governance also drives out good governance. Good governance, to me,
means representing the needs and desires of shareholders or constituents,
and acting on their behalf. It means communicating a vision, providing
leadership and guidance. That sounds like a lot of work. I know of people who
are willing to put in the time and effort, but there are too few of them. Worse,
it doesnt last. Leaders become complacent, believing that their track record
speaks for them, or that relationships from the past dont need to be
refreshed. In this case, fresh energy and enthusiasm need to be injected into
the organisation. This is why we change our government every couple
elections, even if it just means replacing old faces with new ones. We are
really replacing complacency with energy and enthusiasm.

Entropy is a nefarious force that affects all aspects of our world. It means
that, in order to progress and grow, or even just to keep an organization
functioning, requires constant effort and energy. Anything less will cause the
bad to drive out the good until an eventual collapse.