By combining functional MRI (fMRI) with behavioral economic research, neuroscientists and economists at New York University (NYU) have provided new insight into the tendency to overbid at auctions.
Specifically, they show that the fear of losing the social competition inherent in an auction may, in part, cause people to pay too much, according to the study which appears in the Sept. 26 issue of Science.
NYU neuroscientists Elizabeth Phelps, PhD, and Mauricio Delgado, PhD, as well as economists Andrew Schotter, a professor in NYU's department of economics, and Erkut Ozbay, assistant professor in the University of Maryland's department of economics, led the research.
They used functional MRI (fMRI) to examine patterns of brain activation as participants played either an auction game with a partner or a lottery game. In both games, participants could win money, but in the auction game, winning depended on outbidding a partner. An examination of activation in the striatum showed the primary difference when winning or losing in the auction versus lottery games was an exaggerated response to losses in the auction game.
According to the authors, the magnitude of the exaggerated loss response in the striatum during the auction game correlated with the tendency to overbid, suggesting that perhaps the prospect of losing the social competition inherent in an auction may lead people to bid "too high."
To confirm the hypothesis, the researchers conducted a follow-up behavioral economic study in which three groups of participants played an auction game against a partner under different circumstances. The control group was simply given values and asked to make bids. The Bonus-Frame group was told that if they won the auction, they would also receive a bonus of 15 experimental dollars. The Loss-Frame group was given the money prior to the auction, but participants were told they would lose it if they failed to win the auction.
In both the Loss and Bonus-Frame conditions, only the winners would get an additional 15 experimental dollars, so the auctions were strategically identical. The difference was simply the way it was framed to emphasize losing or winning.
Consistent with the hypothesis that contemplation of loss may, in part, drive overbidding, participants in the Loss-Frame condition consistently bid higher than the other two groups, resulting in a greater potential profit for a hypothetical auctioneer.
"These results highlight a role for the contemplation of social loss in understanding the tendency to bid 'too high' in auctions and emphasize the importance of considering social factors in economic decisions," Phelps explained. "By combining neuroeconomic and behavioral economic techniques we were able to provide novel insight into a classic economic problem."