Most web transactions are just "catalog selling meets the internet." Online auction houses are something new that will fundamentally change the way products are sold, on-line and off-line.

In 1996 Ray Gibson, the owner of a computer store in Lebanon, New Hampshire, bought six computer video cards from a wholesaler for $70 each and offered them for sale at $150. The cards sold well and Ray ordered some more. But then sales slowed and an upgrade of the competing product (which Ray also sells) was to arrive in two weeks. He cut the price of the four remaining cards and increased their visibility by placing them in the 'on sale' section of his store. But with the price down to $80 there remained two cards and no prospective buyers. Eventually Ray sold the cards for $25 each to a firm that buys unwanted inventory.

Karen Shackleton owns a similar type of computer store in Burlington, Vermont. Faced with the same situation, Karen dropped the price of her remaining computer cards to $120 and they all sold. Unbeknown to her there were two other residents of Burlington who would have bought the cards if the price had fallen to $90.

There is a fundamental trade off here. When the price is dropped to move the inventory, the idea is that once the price falls below the reservation price (marginal value) of someone who can see the price, then the video card will be sold. Because Ray's is a store in a small town in New Hampshire the number of people who can observe the price is fairly small. Ray could increase that number by advertising in a local paper or directly contact prospective buyers through a mailing list, or whatever. The fundamental trade off is between the cost of expanding the group of people who can see the lowered price and the increased price at which the video cards sell if that group of buyers is expanded. Of course the matching trade-off for buyers is between the length of a search for a lower price and the amount of money saved.

Instead of selling the cards to a consolidator of surplus inventory, Ray could have invited bids for the video cards from likely buyers. However, most goods that are sold by negotiation are of relatively high value and subjective quality - like houses or used cars. Ray does not have the time to negotiate sales of relatively low value goods and in any case does not wish to encourage that atmosphere in his store.

Web sites which offer electronic retailing have not changed these trade-offs much for small retailers. Conceivably, the whole world can see Ray's web site. However, if his store's web site had millions of visits per week, instead of just hundreds of visits, then his business would be worth billions of dollars instead of hundreds of thousands.

Cut to 1999. Enter eBay and the other online auction houses. Miraculously, Ray again has two video cards on the 'on sale' shelf that have been priced at $80 for some time. Ray is approached by a new consolidator who buys surplus inventory and sells it through online auction houses. Ray sells the cards for $50 each. The new consolidator lists them in an online auction and sells one for $90 and in a later auction sells the other for $65. The auction house took 5 percent of the proceeds. Karen also listed two cards and sold them for $75 each.

The online auction houses are not just the internet analog of an existing marketing channel, they are something new and their effect on the exchange of goods and services in the economy will be profound. The main effect of online auctions is a massive decrease in transactions costs. Ray can offer his surplus inventory for sale to millions of potential buyers at no more effort, and at lower cost, than lodging an advertisement in a local paper.

This pooling of information can make everyone better off (except perhaps the inventory consolidator). In 1996 Ray sold his cards to a consolidator even though there were two buyers in Burlington who would have bought his cards at the $80 sale price had they known of Ray's low priced cards. Such a transaction would have made both Ray and the Burlington buyers better off.

The second efficiency of eBay, and its cohort, arises from the method of price formation. The auction automatically reveals the identity of the highest marginal value individual in the group of prospective buyers that can see the price, without any need for negotiation. Moreover, since the buyers do not necessarily know the ultimate number of units for sale, the seller can capture a lot of buyers' consumer surplus by selling the goods one by one; each time to the individual with the highest marginal value. This is a higher level of price discrimination than could otherwise be achieved.

A final observation is that online auctions will accelerate the unbundling of products and the sales services associated with the product. Buyers who need advice on what type of video card to purchase and how to install it, or who need immediate access to the product, will buy directly from Ray and pay the price that goes with that level of service and immediacy. Other buyers who do not need the service will be more inclined to purchase goods from online auctions.

There is a mythical figure in the world of academic economists called the Walrasian Auctioneer who raises and lowers the price in a market, taking and tallying bids from buyers and sellers, until a market clearing price is arrived at. The auctioneer existed in the models of economists for many years to simplify assumptions about who knew what and how prices are set, so that the models could concentrate instead on other economic questions of interest. eBay is the price discriminating Walrasian Auctioneer brought to life in the brave new world of internet commerce.