Farooq Sabri

Microeconomics Essay Auction houses (such as Sotheby's) selling 'old masters', recently added a 'buyer's premium' to the 'seller's premium' they had traditionally charged. Analyse the effect of this on the net price received by the seller and the gross price paid by the buyer. The addition of a buyers premium (a commission paid by the buyer as a percentage of the total bid price) to a sellers premium, allowing the auction houses to spread their fees onto both the buyer and seller1; will have a strong impact on the auction transaction, impacting both the consumer and producer surplus. In this essay I will address this change which will be reflected in the prices paid by the buyer and the net price received by the seller2. In answering this question we must first consider the type of market which an auction house operates in. Firstly, an auction house specialising in the selling of old masters indicates a good with a perfectly inelastic supply curve (a painting like the Mona Lisa is unique and the painter is now deceased). Similarly, we can also distinguish paintings from other consumptive goods in that they are assets, with a strong store of value. We can think of price as being a quantitative measure of utility, with the person who is willing to pay the highest price being the person who derives the most utility from the painting. Another way of measuring consumer surplus involves looking at an individuals marginal willingness to pay, measuring the value that individuals place on purchasing one more unit of that good. In this instance the MWTP; considering supply cannot exceed one; is the value that is placed on the purchase of the good as a whole. Auction houses like Sothebys tend to operate under the English auction system whereby buyers compete by bidding up the price until there is only one bidder who pays the final hammer price. Such a system maximises price for the seller, since it identifies the individual who is willing to pay the highest price. However the buyer is still likely to derive some consumer surplus; which we define as the amount buyers benefit by purchasing a good below the maximum amount that they were willing to pay since the actual price that the winning bidder pays is equivalent to the marginal utility of the second highest bidder and not their own utility. The purchaser is thus only likely to pay for a good up until their own valuation (when the price equals their marginal utility). Furthermore, in this particular context, we can assume that paintings are often purchased as assets with a strong resale value and it would therefore make sense for the buyer to purchase the good at a value below what they think it may be worth in the future (we can consider the difference between this value and the price that he actually pays to be his consumer surplus). If we now consider the addition of the buyers premium, we can see that if this paid on top of the successful bidders price, assuming he pays his maximum price (such that consumer surplus is zero), the bidder will be paying in excess of the marginal utility which he derives from the purchase. In this case it makes sense for a rational buyer to factor in the buyers premium when bidding. This would mean that the successful bid would be less than the bid pre-premium by an amount equivalent to the buyers premium; however his total payment will still equal his marginal utility.
1 In reality, the actual net sale income of the seller is more or less unchanged since the addition of the buyers premium was introduced with the intention of lowering the burden of commission paid by the seller in the form of a sellers premium (the percentage premium is now bared by both the buyer and seller instead of just the seller); so the sellers lower sale income is compensated for by a lower premium. However this is based solely on the assumption that the sum of both the buyers and sellers premium equals the sellers premium paid before the introduction of the buyers premium. Although, the question implies a premium in addition to an unchanged sellers premium so we cannot assume this. 2 In my analysis I have ignored the sellers premium since it is taken to be constant.

Farooq Sabri

Furthermore, we could draw comparisons with this premium and the effects of a consumptive tax where we expect to see a leftward shift in demand. However, in this type of transaction, the total payment is still equal to the pre-premium price. This is because the bidder adapts his behaviour by lowering his bidding price (by an amount equivalent to the buyers premium) such that the sum of the bid price and the premium equates to the original price as I have just explained. Such a difference will translate into a lower price received by the seller. This can be described as a fall in producer surplus (the difference between the marginal utility as measured by the minimum price the seller will accept and the price they actually receive). This is because, post-premium, the seller is now receiving a lower equivalent hammer price, while the auction house receives a greater proportion of the sale income in the form the buyers premium. This fall in producer surplus is equivalent to the buyers premium. This represents a transfer of producer surplus from the seller to the profits of the auction house. Word Count: 881