The dollar auction is a non-zero sum sequential game designed by economist Martin Shubik to illustrate a paradox brought about by traditional rational choice theory in which players with perfect information in the game are compelled to make an ultimately irrational decision based completely on a sequence of rational choices made throughout the game.

Setup

The setup involves an auctioneer who volunteers to auction off a dollar bill with the following rule: the dollar goes to the highest bidder, who pays the amount he bids. The second-highest bidder also must pay the highest amount that he bid, but gets nothing in return. Suppose that the game begins with one of the players bidding 1 cent, hoping to make a 99 cent profit. He will quickly be outbid by another player bidding 2 cents, as a 98 cent profit is still desirable. Similarly, another bidder may bid 3 cents, making a 97 cent profit. Alternatively, the first bidder may attempt to convert their loss of 1 cent into a gain of 97 cents by also bidding 3 cents. In this way, a series of bids is maintained. However, a problem becomes evident as soon as the bidding reaches 99 cents. Supposing that the other player had bid 98 cents, they now have the choice of losing the 98 cents or bidding a dollar even, which would make their profit zero. After that, the original player has a choice of either losing 99 cents or bidding $1.01, and only losing one cent. After this point the two players continue to bid the value up well beyond the dollar, and neither stands to profit.