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What are penny auctions? Given the great discounts they claim (up to 95%), how do they make money?

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closed as off-topic by FooBar, optimal control, Hector, jmbejara Feb 9 '16 at 22:57

  • This question does not appear to be about economics, within the scope defined in the help center.
If this question can be reworded to fit the rules in the help center, please edit the question.

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    $\begingroup$ I'm voting to close this question as off-topic $\endgroup$ – FooBar Feb 7 '16 at 16:11
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    $\begingroup$ @FooBar Actually, the linked site is a penny auction. It wouldn't be awful to have a Q&A here on how penny auctions work. $\endgroup$ – Shane Feb 7 '16 at 23:17
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    $\begingroup$ I've edited the question and provided an answer that I hope will answer the OP's question and provide a useful reference going forward. I hope people will reconsider close votes. $\endgroup$ – Shane Feb 7 '16 at 23:32
  • $\begingroup$ I do not think this question should be closed. In order to understand how penny auctions make money, you need some sort of conceptual model of how people bid in such auctions, which puts them squarely in the domain of economics. $\endgroup$ – Ubiquitous Feb 10 '16 at 16:03
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In a penny auction, each bid raises the going price of an object by just one penny. However, placing such a bid is costly whether or not you win. Usually it costs one dollar to place a bid -- sometimes this is obfuscated by making you purchase bids (or bidding credits) before you participate. In any case, if the opening bid of an auction for something is 0.01, and the auction ends with the price at just 10, then one thousand bids have been placed and therefore the site has made 1,000 on top of what the item actually sells for (10). So if the item has a value of 500, then they would represent that as 98% discount even though they actually made a profit of 510, simply because they ignore the bidding costs (their primary source of profit).

Now, if you happen to be the person who makes the winning bid, and you have not bid previously, then obviously you would be getting a very good deal -- in the example above, you would be paying 11 for an item that might be worth 100 or more. However, it is difficult (and out of your control) to be the winning bidder. After every bid, time is allowed for other bidders to outbid you, in which case you lose the money you spent on the bid.

With all of this in mind, participating in penny auctions is essentially gambling. Sites that market these discounts and obfuscate the cost of bidding are highly misleading. I personally believe they should be banned. Note that these penny auction sites should not be confused with standard auction sites like Ebay. In standard auction sites, you pay only if you win -- you do not pay simply to make a bid.

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    $\begingroup$ It's also worth mentioning that some penny auction sites may use shill bidders to continually extend the auction. $\endgroup$ – dwjohnston Feb 9 '16 at 1:51

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