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Why you pay too much when buying through an auction

The trigger for this post was a headline I read in the paper “Cashed-up older buyers pay $325k over reserve”. A 3-bedroom house in Brunswick, a suburb of Melbourne, was sold at auction in December 2019 for 325,000 $ above its reserve.
The auction must have been frantic with the auctioneers playing the potential buyers off against each other and creating a competitive environment. This is dangerous as people then lose sight of the true value and the want to win takes over and subsequently people end up paying too much.

So, what is happening to us when we are in an auction and why do we tend to overbid?
A study conducted by a team of neuroscientists and economists at the NYU tried to understand exactly that question. Our prefrontal cortex is the part of our brain where our logical and complex decisions are performed. Our unconscious decision-making process is performed in a different part of our brain which is called the Striatum. This also the part of where our fight or flight response is performed; it is the part of our brain that responses to threat.
The researchers have used fMRI, functional magnetic resonance imaging, to examine patterns of brain activation while the participants where participating in an auction. They found that rational decision making diminishes and the principle of act first and think then kicks in out of fear of loss. The excitement of the bidding process releases dopamine which controls the pleasure centre of the brain and makes the bidder feel good, hence the bidding continues, and more dopamine is released, a vicious circle.
This explains why people at an auction can lose all rationality and continue to bid until later rationality kicks back in and they then think ‘oh what have I done’.
The phenomenon that occurs is called auction fever. This is created in an environment where emotions are running high with the urge to win. It is the increase in emotions that bidders experience during the auction. It is that high level of arousal and the urge to win that is created in such an environment.  This results in the bidder to lose their ability to think clearly.
The researchers Ariely and Simonson (2003) found that 76% of bidders consider the other fellow bidders as competitors. The outcome of the auction is described by the participants as either winning or losing.
The following elements trigger auction fever:

Perceived ownership
Research in behavioural economy has found that perceived ownership refers to the assumption that the highest bidder feels like already being the owner of the item they are bidding on. The term ‘endowment effect’ was introduced by behavioural economist Richard Thaler; the endowment effect is the impact whereby we value something more if we are the owner of the object. During the bidding process the highest bidder develops a ‘pseudo endowment effect’ (Ariely and Simonson 2003) which refers to the situation where the highest bidder gets attached to the object without actually owning it yet.

Time Pressure
Behavioural research in decision making has found that time pressure creates arousal and increases the willingness to take risks. During auctions the bidders are put under time pressure, so they have less time to think and are quick in making decisions. This results in the bidder not being able to think clearly and taking decisions in the heat of the moment.

Audience effect
In a public auction the bidders feel put under the spotlight and feel that they are being watched. Competitive behaviour I triggered when the auction is public and the need to win becomes greater which then leads to competitive arousal and over bidding.

Rivalry
Rivalry is an essential attribute of any public auction. There is a level of excitement and rivalry that is created in an auction environment to create the need to win at all cost.

Thaler, R. H. (1980). Toward a positive theory of consumer choice. Journal of Economic Behavior & Organization, 1(1), 39–60.
Ariely, D., & Simonson, I. (2003). Buying, bidding, playing, or competing? value assessment and decision dynamics in online auctions. Journal of Consumer Psychology, 13, 113–1

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