What is a 'Dollar Auction'

Designed by economist Martin Shubik, a dollar auction illustrates a paradox of rational choice theory which assumes that a person will always make the most logical decision. 

The auction is a non-zero-sum, sequential game where each person will gain or lose as an exact balance of their opponent's gains and losses. ​​​​​​​

BREAKING DOWN 'Dollar Auction'

A dollar action is a simple game, where two participants bid on a dollar bill. The highest bidder receives the bill. However, the loser must pay the amount that they offered as well. When bidding in the game begins to approach, or go beyond, $1 the player' game goal changes. Instead of maximizing their potential gain, players now try to minimize their potential loss. 

A dollar auction starts with an auctioneer accepting the initial bids of two participants. After that, it does not make sense for them to stop bidding up the price. For example, if an auction leads to Participant A bidding 90 cents, followed by a $1 bid from Participant B, Participant A can either offer $1.01 and lose 1 cent or drop out of the auction and lose 90 cents. 

Bidding more than a dollar, for a dollar, is not logical. At the same time, losing 90 cents is not as smart as losing 1 cent.

In this game, the rational move would be to place the bid which leaves Participant B in a similar situation. In other words, either bid $1.02 and lose 2 cents or drop out and lose the dollar.

In theory, the bidding process could continue in perpetuity as long as both players remain committed to winning the dollar.

What ‘Dollar Auction’ Illustrates

The dollar auction shows how rational behavior can lead to an undesirable outcome. In that sense, it is similar to the more widely known prisoner's dilemma, which stipulates that rational individuals might not cooperate with each other, even when it appears that it would be in their best interest to do so.

American economist Martin Shubik invented the dollar auction to reveal the consequences of what he called the “escalation of commitment.” Shubik, a pioneer in game theory, posited that the dollar auction shows how people can become obsessed with the idea of losing, even though they know that they can still lose by winning. 

In his 1971 articleThe Dollar Auction game: A paradox in noncooperative behavior and escalation, Shubik indicated that he particularly enjoyed seeing the game’s dynamics play out in party settings and front of a large crowd. “Once two bids have been obtained from the crowd, the paradox of escalation is real. This simple game is a paradigm for escalation. Once joining the contest, the odds are that the end will be a disaster to both.”

  1. Auction

    An auction is a process where potential buyers place competitive ...
  2. Auction House

    A company that facilitates the buying and selling of assets, ...
  3. Reserve Price

    A reserve price is the minimum amount that the owner of an item ...
  4. Reverse Auction

    A reverse auction is a type of auction in which sellers bid for ...
  5. Auction Rate Security - ARS

    An auction rate security (ARS) is a debt security that is sold ...
  6. All-Pay Auction

    An all-pay auction is an economic and game theory concept in ...
Related Articles
  1. Personal Finance

    How The Auction Market Works

    Here's a look into the online auction market and how to get yourself the best value possible on sites like eBay and Quibids.
  2. Personal Finance

    Auction Rate Securities: Bidding On The Long Run

    These investments do better with a long-term horizon. Should you buy them before they're going, going, gone?
  3. Insights

    The Basics Of Game Theory

    Take an introductory look at game theory and the terms involved, and get familiar with backwards induction, a simple method for solving games.
  4. Investing

    The History Of The T-Bill Auction

    Learn how the U.S. found the perfect solution to its debt problems and ended up creating one of the largest markets in the world.
  5. Investing

    The Auction Method: How NYSE Stock Prices are Set

    Find out how the New York Stock Exchange (NYSE) runs an auction process known as open outcry to set stock prices during the opening and closing auctions.
  6. Managing Wealth

    How To Master Online Auctions For Fast Cash

    Online selling is just as easy as in-person selling and can yield five to 10 times the profit.
  7. Tech

    How The Video Game Industry Is Changing

    Video game creation has become increasingly complex, and the cost of creating a game to run on one of the major consoles has risen with this greater complexity.
  8. Investing

    Gaming ETFs Take Off

    The gaming industry is on the rise thanks to global hotspots like China.
  9. Insights

    Get Positive Earnings In The Negative-Sum Market

    Gain an advantage in the markets by understanding how to win in a negative-sum game.
  10. Trading

    Credit Default Swaps: What Happens in a Credit Event?

    The credit crisis of 2008 prompted important changes to the settlement of credit default swaps.
  1. What do the bid and ask prices represent on a stock quote?

    The bid and ask prices are stock market terms representing the supply, or the shareholder, and demand, or investor, for a ... Read Answer >>
  2. Quote driven and order driven markets: What's the difference?

    The difference between these two market systems lies in what is displayed in the market in terms of orders and bid and ask ... Read Answer >>
Trading Center