What They Know That You Don’t

Auctions and Mechanism Design · Open board

The auction board quietly assumes each bidder knows what the item is worth to them and nobody else does. This lesson makes that hidden knowledge the whole game: one side knows something, the other has to guess, and the guessing changes what both of them do.

Before you start. From Decision-Making Under Uncertainty you have expected value: weigh each outcome by how likely it is and add them up. From Draw the Tree, Start From the End you have the game tree, read backward. Every game so far assumed both players knew the payoffs. Here one player knows something the other does not.

The idea in 30 seconds

When one side knows something the other cannot see, the hidden fact is that player’s type, and the other side has to reason with the odds.
If buyers can only pay for average quality, owners of good things leave, the average falls, and a market can shrink round after round: adverse selection.
With good and bad cars at the lesson’s values, the market keeps its good cars only while lemons are under a third of it.
A signal works when it is cheap for the good type and too expensive for the bad type to fake.
Screening lets the uninformed side offer a menu so that each type picks the option meant for it, which is why the cheap option is often made worse on purpose.
Moral hazard is the hidden action after a deal, fixed by making the person who acts carry part of the cost.

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