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Market-Based Solutions to Vital Economic Issues
Research
Apr 22, 2013

Simple Auctions for Supply Contracts

Abstract

This paper studies an optimal procurement mechanism for a newsvendor-like problem where the buyer’s (newsvendor’s) purchase price of the supplies is not fixed, but determined through interaction with candidate suppliers. The buyer has priors on the suppliers’ costs but does not know their costs exactly. Recent literature has shown how the buyer can implement the optimal procurement mechanism by announcing a revenue function (specifying a payment for each quantity the buyer may purchase), then auctioning off the supply contract with the specified revenue function. In this paper, we show that a simple modified version of the standard open-descending auction for a fixed quantity is also an optimal mechanism for obtaining supplies. What distinguishes this mechanism is its simplicity and familiarity for the suppliers—open-descending auctions are very easy to run and ubiquitous in practice, whereas auctioning supply contracts with a specified revenue function is much less observed and more difficult to explain to suppliers. Furthermore, we show that this simple mechanism can be easily generalized to ex ante asymmetric suppliers and a class of nonlinear production costs.

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