eBay operates the world’s largest online auction. In early 2008, eBay operated in 39 counties with 276 million registered users worldwide. The total value of all successfully closed items in 2007 was $59 billion with an average of $2,039 worth of goods trad- ing on the site every second. Sellers pay a small fee to eBay to list their items. They provide a description of the item, photographs, the minimum acceptable bid, accepted forms of payment, and other relevant information. Items can be sold at a fixed price or through an auction. In an auction, bidders submit electronic bids over the Internet. After the auction closes (auctions usually last several days), the high bidder receives an e-mail. The high bidder must con- tact the seller within three business days to claim the item and arrange payment and delivery. eBay pro- vides other support services: The Feedback Forum is a place where eBay users leave comments about each other’s buying and selling experiences. If you are a bidder, you can check the seller’s Feedback Profile easily before you place a bid to learn about the other buyers’ experience. If you’re a seller, you can do the same thing to check out buyers. Each participant is given a Feedback Score based on the number of positive and negative ratings that they have received. Par- ticipants with sufficient positive ratings are flagged by colored stars. The highest rating is the “Red shooting star.” eBay has created a set of policies to guard against “feedback manip- ulation” and “feedback abuse.” eBay users are encouraged to settle transac- tions through PayPal. PayPal provides free insurance of up to $2,000 on some items to protect buyers in cases where they do not receive the item or it was less than expected. Participants sign user agreements that specify the trading rules and expectations. eBay’s safety staff investigates alleged misuses at eBay such as fraud, trading offenses, and illegally listed items. Potential resolutions include such things as banning a person from future trading on eBay.

1. How does eBay create value?

2. What potential contracting problems exist on eBay?

3. How does eBay address these problems?

4. What are the contracting costs at eBay?

5. eBay claims that it has only a small problem with fraud and misuse of the system. Does this imply that it is overinvesting in addressing potential contracting problems? Underinvesting? Explain.