This lecture brings together everything built up to this point.  We are going to develop an intuition for why competitive markets are efficient using a model of profit maximizing sellers who compete in an auction market by setting reserve prices.  In the previous lecture we saw how the profit maximization motive leads a seller with market power to choose an inefficient selling mechanism.  This came in the form of a reserve price above cost.  Here we begin by getting some intuition why competition should reduce the incentive to distort price in this way.

(This is probably the weak link in the whole class.  I do not have a good idea of how to teach this and in fact I am not sure I understand it so well myself.  This is the first place to work on improving the class next time.  Any suggestions would be appreciated.)

Finally, we jump to a model with a large number of buyers and sellers all competing in a simultaneous ascending double auction.  With so much competition, if sellers set reserve prices above their costs there will be

  • no sellers who are doing better than if they just set the reserve price equal to cost
  • a positive mass of sellers who would do strictly better by reducing their reserve price to equal their cost

In that sense it is a dominant strategy for all sellers to set reserve price equal to their cost.  This equates the “supply” curve with the cost curve and produces the utilitarian allocation.  Here are the notes.