Optimal Design of Internet-Based Auctions

Online auctions are a profitable, exciting, and dynamic part of electronic commerce, and behave in ways, which do not match classical auction theory. This paper models an online auction in terms of a Markov chain on a state space defined by the current price of the item and the number of bidders who have been previously bumped. It provides a mathematical model, some approximations, which were necessary to convert it into a tractable problem and solutions to a small and a medium-sized theoretical auction. The model results were validated through a comparison with real-world online auction data, showing promise as a predictor of final auction prices. The results of the auction model are also useful in solving an optimization problem that incorporates inventory management considerations in determining optimal auction size.