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Fields:

Industrial Organization

Research:

A Dynamic Procurement Auction with Persistent Backlog and Capacity Constraints , (May 2008)

Abstract: We consider the problem of a procurer who uses an infinite horizon first price dynamic procurement auction to procure a stream of projects. Holding average procurement fixed, should this procurer auction off small-sized projects frequently or should it hold more infrequent auctions for lumpier project sizes by bundling its demand for several periods? To answer this question, we formulate and numerically solve for the Markov Perfect Equilibrium (MPE) of an infinite horizon procurement auction in which bidder asymmetry is generated and evolves endogenously. In the model, the bidding firms are subject to capacity constraints, their backlog of work may persist for several periods and their costs are probabilistically increasing in their capacity utilization. We find that under constant returns to scale, bundling leads to higher procurement costs and is less efficient than holding frequent auctions for small sized projects. The intuition is that bidder asymmetry is costly for the procurer and lumpy contract allocation leads to sequences of auctions where bidders are more asymmetric on average than less lumpy policies. We also find that the option value of winning a project tends to ameliorate static asymmetry between bidders. This effect becomes stronger as the bidders become more forward looking. As a result, as the discount factor increases, the efficiency of any bundling policy increases, although it still remains cost minimizing to have frequent auctions for small projects. Under increasing returns to scale we find that the procurer may reduce its costs only if its allocation is sufficiently lumpy. However, there is a tradeoff between cost reduction and efficiency.

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Conference Presentations:

International Industrial Organization Conference (Arlington, VA), May 2008.

Annual Meetings of the Canadian Economics Association (Vancouver, BC), June 2008.

La Pietra-Mondragone Workshop (Florence), June 30-July 2, 2008.

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