Econ 805 Advanced Micro Theory 1

Econ 805Advanced Micro Theory 1 Dan Quint Fall 2009 Lecture 4

Today: Necessary and Sufficient Conditions For Equilibrium • Problem set 1 online shortly • Last lecture: integral form of the Envelope Theorem holds in equilibrium of any Independent Private Value auction where • The highest type wins the object • The lowest possible type gets expected payoff 0 • Today: necessary and sufficient conditions for a particular bidding function to be a symmetric equilibrium in such an auction

Today’s General Results • Consider a symmetric independent private values model of some auction, and a bid function b : T  R+ • Define g(x,t) as one bidder’s expected payoff, given type t and bid x, if all the other bidders bid according to b • Under fairly broad (but not all) conditions: “everyone bidding according to b” is an equilibrium b strictly increasing and g(b(t’),t’) – g(b(t),t) = òtt’ FN-1(s) ds

Necessary Conditions

With symmetric IPV, b strictly increasing implies the envelope theorem • If everyone bids according to the same bid function b, • And b is strictly increasing, • Then the highest type wins, • And so the envelope theorem holds • So what we’re really asking here is when a symmetric bid function must be strictly increasing

When must bid functions be increasing? • Equilibrium strategies are solutions to the maximization problem maxxg(x,t) • What conditions on g makes every selection x(t) from x*(t) nondecreasing?

When must bid functions be increasing? • Recall supermodularity and Topkis • Strong Set Order: two sets A, B. A ³SSO B if for every x’ > x,(x’ Î B and x Î A)  (x Î B and x’ Î A). • (What this means visually.) • A function g : X x T  R has increasing differences if for every x’ > x, the difference g(x’,t) – g(x,t) is nondecreasing in t • Topkis: if g(x,t) has increasing differences and t’ > t, thenx*(t’) ³SSO x*(t) • This means there exists some selection x(t) from x*(t) which is monotonic • But it does not guarantee that every selection is monotonic, so it doesn’t answer our question • We need something stronger than increasing differences in some ways (although what we use is weaker in others)

Single crossing and single crossing differences properties (Milgrom/Shannon) • A function h : T  R satisfies the strict single crossing property if for every t’ > t, h(t) ³0  h(t’) > 0 (Also known as, “h crosses 0 only once, from below”) • A function g : X x T  R satisfies the strict single crossing differences property if for every x’ > x, the function h(t) = g(x’,t) – g(x,t) satisfies strict single crossing • That is, g satisfies strict single crossing differences if g(x’,t) – g(x,t)³0  g(x’,t’) – g(x,t’) > 0 for every x’ > x, t’ > t • (When gt exists everywhere, a sufficient condition is for gt to be strictly increasing in x)

What single-crossing differences gives us • Theorem.* Suppose g(x,t) satisfies strict single crossing differences. Let S Í X be any subset. Let x*(t) = arg maxx Î S g(x,t), and let x(t) be any (pointwise) selection from x*(t). Then x(t) is nondecreasing in t. • Proof. Let t’ > t, x’ = x(t’) and x = x(t). • By optimality, g(x,t)³g(x’,t) and g(x’,t’)³g(x,t’) • So g(x,t) – g(x’,t)³ 0 andg(x,t’) – g(x’,t’) £ 0 • If x > x’, this violates strict single crossing differences * Milgrom (PATW) theorem 4.1, or a special case of theorem 4’ in Milgrom/Shannon 1994

Strict single-crossing differences will hold in “most” symmetric IPV auctions • Suppose b : T  R+ is a symmetric equilibrium of some auction game in our general setup • Assume that the other N-1 bidders bid according to b;g(x,t) = t Pr(win | bid x) – E(pay | bid x) = t W(x) – P(x) • For x’ > x, g(x’,t) – g(x,t) = [ W(x’) – W(x) ] t – [ P(x’) – P(x) ] • When does this satisfy strict single-crossing?

When is strict single crossing satisfied byg(x’,t) – g(x,t) = [ W(x’) – W(x) ] t – [ P(x’) – P(x) ] ? • Assume W(x’)³W(x) (probability of winning nondecreasing in bid) • g(x’,t) – g(x,t) is weakly increasing in t, so if it’s strictly positive at t, it’s strictly positive at t’ > t • Need to check that if g(x’,t) – g(x,t) = 0, then g(x’,t’) – g(x,t’) > 0 • This can only fail if W(x’) = W(x) • If b has convex range, W(x’) > W(x), so strict single crossing differences holds and b must be nondecreasing (e.g.: T convex, b continuous) • If W(x’) = W(x) and P(x’) ¹ P(x)(e.g., first-price auction, since P(x) = x), then g(x’,t) – g(x,t) ¹ 0, so there’s nothing to check • But, if W(x’) = W(x) and P(x’) = P(x), then bidding x’ and x give the same expected payoff, so b(t) = x’ and b(t’) = x could happen in equilibrium • Example. A second-price auction, with values uniformly distributed over [0,1] È [2,3]. The bid function b(2) = 1, b(1) = 2, b(vi) = vi otherwise is a symmetric equilibrium. • But other than in a few weird situations, b will be nondecreasing

b will almost always be strictly increasing • Suppose b(-) were constant over some range of types [t’,t’’] • Then there is positive probability (N – 1) [ F(t’’) – F(t’) ] FN – 2(t’) of tying with one other bidder by bidding b* (plus the additional possibility of tying with multiple bidders) • Suppose you only pay if you win; let B be the expected payment, conditional on bidding b* and winning • Since t’’ > t’, either t’’ > B or B > t’, so either you strictly prefer to win at t’’ or you strictly prefer to lose at t’ • Assume that when you tie, you win with probability greater than 0 but less than 1 • Then you can strictly gain in expectation either by reducing b(t’) by a sufficiently small amount, or by raising b(t’’) by a sufficiently small amount • (In addition: when T has point mass… second-price… first-price…)

So to sum up, in “well-behaved” symmetric IPV auctions, except in very weird situations, • any symmetric equilibrium bid function will be strictly increasing, • and the envelope formula will therefore hold • Next: when are these sufficient conditions for a bid function b to be a symmetric equilibrium?

Sufficiency

What are generally sufficient conditions for optimality in this type of problem? • A function g(x,t) satisfies the smooth single crossing differences condition if for any x’ > x and t’ > t, • g(x’,t) – g(x,t) > 0  g(x’,t’) – g(x,t’) > 0 • g(x’,t) – g(x,t) ³ 0  g(x’,t’) – g(x,t’) ³ 0 • gx(x,t) = 0  gx(x,t+d) ³ 0 ³ gx(x,t – d) for all d > 0 • Theorem. (PATW th 4.2) Suppose g(x,t) is continuously differentiable and has the smooth single crossing differences property. Let x : [0,1]  R have range X’, and suppose x is the sum of a jump function and an absolutely continuous function. If • x is nondecreasing, and • the envelope formula holds: for every t, g(x(t),t) – g(x(0),0) = ò0t gt(x(s),s) ds then x(t) Î arg maxx Î X’ g(x,t) • (Note that x only guaranteed optimal over X’, not over all X)

But… • Establishing smooth single-crossing differences requires a bunch of conditions on b • We can use the payoff structure of an IPV auction to give a simpler proof • Proof is taken from Myerson (“Optimal Auctions”), which we’re doing on Thursday anyway

Claim • Theorem. Consider any auction where the highest bid gets the object. Assume the type space T has no point masses. Let b : T  R+ be any function, and define g(x,t) in the usual way. If • b is strictly increasing, and • the envelope formula holds: for every t, g(b(t),t) – g(b(0),0) = ò0t FN-1(s) ds then g(b(t),t) ³ g(b(t’),t), that is, no bidder can gain by making a bid that a different type would make. If, in addition, the type space T is convex, b is continuous, and neither the highest nor the lowest type can gain by bidding outside the range of b, then everyone bidding b is an equilibrium.

Proof. • Note that when you bid b(s), you win with probability FN-1(s); let z(s) denote the expected payment you make from bidding s • Suppose a bidder had a true type of t and bid b(t’) instead of b(t) • The gain from doing this is • g(b(t’), t) – g(b(t), t) = t FN-1(t’) – z(t’) – g(b(t),t) • = (t – t’) FN-1(t’) + t’ FN-1(t’) – z(t’) – g(b(t),t) • = (t – t’) FN-1(t’) + g(x(t’),t’) – g(x(t),t) • Suppose t’ > t. By assumption, the envelope theorem holds, so • = (t – t’) FN-1(t’) + òtt’ FN-1(s) ds • = òtt’ [ FN-1(s) – FN-1(t’) ] ds • But F is increasing (weakly), so FN-1(t’)³FN-1(s) for every s in the integral, so this is (weakly) negative • Symmetric argument holds for t’ < t • So the envelope formula is exactly the condition that there is never a gain to deviating to a different type’s equilibrium bid

Proof. • All that’s left is deviations to bids outside the range of b • With T convex and b continuous, the bid distribution has convex support, so we only need to check deviations to bids above and below the range of b • Assume (for notational ease) that T = [0,T] • If some type t deviated to a bid B > b(T), his expected gain would be • g(B,t) – g(b(t),t) = [ g(B,t) – g(b(T),t) ] + [ g(b(T),t) – g(b(t),t) ] • The second term is nonpositive (another type’s bid isn’t a profitable deviation) • We also know g(x,t) = t Pr(win | bid x) – z(x) has increasing differences in x and t, so for B > b(T), if g(B,t) – g(b(T),t) > 0, g(B,T) – g(b(T),t) > 0 • So if the highest type T can’t gain by bidding above b(T), no one can • By the symmetric argument, we only need to check the lowest type’s incentive to bid below b(0) • (If b was discontinuous or T had holes, we would need to also check deviations to the “holes” in the range of b) • QED

So basically, in well-behaved symmetric IPV auctions, • b : T  R+is a symmetric equilibrium if and only if • b is increasing, and • b (and the g derived from it) satisfy the envelope formula

Up next… • Recasting auctions as direct revelation mechanisms • Optimal (revenue-maximizing) auctions • Might want to take a look at the Myerson paper, or the treatment in one of the textbooks • If you don’t know mechanism design, don’t worry, we’ll go over it

Econ 805 Advanced Micro Theory 1