- An initial price is displayed. This is usually a low price – it may be either 0 or the seller’s reserve price.
- All buyers that are interested in buying the item at the displayed price enter the auction arena.
- The displayed price increases continuously, or by small discrete steps (e.g. one cent per second).
- Each buyer may exit the arena at any moment.
- No exiting buyer is allowed to re-enter the arena.
- When a single buyer remains in the arena, the auction stops. The remaining buyer wins the item and pays the displayed price.
Suppose a buyer believes that the value of the item is v. Then this buyer has a simple dominant strategy: stay in the arena as long as the displayed price is below v; exit the arena whenever the displayed price equals v. This means that the Japanese auction is a truthful mechanism: it is always best to act according to your true value, regardless of the others’ values.
When all buyers play their dominant strategies, the outcome is:
- The winning buyer is the buyer with the highest valuation;
- The final price is the second-highest valuation.