DEFINITION of 'Dollar Auction'
The basic dollar auction is based on the auction of a $1 bill between two individuals. A dollar auction is a non-zero-sum game, which, like the prisoner's dilemma, reveals that rational behavior can often lead to an undesirable consequence. The winner of the auction receives the bill while the other participant must pay the price of his last bid.
BREAKING DOWN 'Dollar Auction'
After both participants have put in their initial bids, logically it doe not make sense for them to stop bidding up the price. For example, if participant A bids 90 cents, which is followed by a $1 bid from participant B, participant A can either bid $1.01 and lose 1 cent or drop out of the auction and lose 90 cents. Rationally, the bid should be placed. Participant B is now left in a similar situation where he can bid $1.02 or drop out, resulting in respective losses of 2 cents or $1. The bidding process would theoretically continue to perpetuity as both players stay committed to the losing cause.