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Internet Advertising and the Generalized Second-Price Auction: Selling Billions of Dollars Worth of Keywords BENJAMIN EDELMAN, MICHAEL OSTROVSKY, AND MICHAEL.

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Presentation on theme: "Internet Advertising and the Generalized Second-Price Auction: Selling Billions of Dollars Worth of Keywords BENJAMIN EDELMAN, MICHAEL OSTROVSKY, AND MICHAEL."— Presentation transcript:

1 Internet Advertising and the Generalized Second-Price Auction: Selling Billions of Dollars Worth of Keywords BENJAMIN EDELMAN, MICHAEL OSTROVSKY, AND MICHAEL SCHWARZ American Economic Review, vol. 97(1), March, 2007 Bo Zhou

2 Generalized First-Price Auction Advertisers get positions according to their bids. Each one pays exactly the amount of his or her bid for each click. Suppose we have three bidders and two advertising positions with CTRs of 200 and 100, respectively. Advertiser Per-click Value BidPayoff Windows Mac Linux220 2

3 Generalized First-Price Auction But smart advertisers always try to minimize costs. 3 Advertiser Per-click Value BidPayoff Mac Windows Linux220 Advertiser Per-click Value BidPayoff Windows Mac Linux220

4 Generalized First-Price Auction Using GFP, the auction can be extremely volatile, even chaotic. Bidders have strong incentives to “game” the system by slightly outbidding the advertiser right above. The ad sellers ultimately swallow the loss. Consider the following example in which Windows employs a bidding robot while both Mac and Linux bid manually. Advertiser Per-click Value BidPayoff Windows Mac Linux220 4

5 Vickrey–Clarke–Groves Auction (VCG) Advertisers get positions according to their bids. Each one pays the “externality” he or she imposes on others by taking one slot away. Advertiser Per-click Value BidPaymentPayoff Windows Mac44200 Linux2200 A B C D A C D B should pay what C and D lose. 5

6 VCG Auction Truth-telling is a dominant strategy under VCG. A dominant strategy performs at least as well as any other strategy in any situation. Simply put, it is one of your best responses to the auction. Still, ad seller’s revenue suffers. 6

7 Generalized Second-Price Auction Advertisers get positions according to their bids. Each one pays the amount of bid of the advertiser right blew for every click. Consider the following example where everybody bids truthfully. Advertiser Per-click Value BidPaymentPayoff Windows Mac Linux2200 It appears that nobody has any incentive to shift bidding strategy because nobody will be better off by doing so! 7

8 Generalized Second-Price Auction This situation is called an equilibrium. In an equilibrium, everyone chooses the best strategy by taking into account every other’s strategy. In other words, nobody can be better off by shifting strategy unilaterally. The example on the last slide shows that using truth-telling strategy under GSP can produce equilibrium. From an bidder’s perspective, using truth-telling strategy under GSP can maximize its payoff. Just sometimes!!! 8

9 Generalized Second-Price Auction Let’s consider a similar example where the CTRs of both positions are now 200 and 199. If all three bidders stick to the truth-telling strategy. Advertiser Per-click Value BidPaymentPayoff Windows Mac Linux2200 Advertiser Per-click Value BidPaymentPayoff Mac Windows Linux2200 However, what if Windows decides to change course? 9

10 Locally envy-free Equilibrium Equilibrium looks fine, but is it stable? Not necessarily. An advertiser may have incentives to behave aggressively to swap positions with the advertiser right above him or her. 10

11 Locally envy-free Equilibrium 11 Advertiser Per-click Value BidPaymentPayoff Windows Mac Linux3300 Now CTRs change to 300 and 100, respectively. Mac wants to provoke. Advertiser Per-click Value BidPaymentPayoff Windows Mac Linux3300

12 Locally envy-free Equilibrium 12 Apparently, Windows would like to retaliate. Advertiser Per-click Value BidPaymentPayoff Mac Windows Linux3300 Locally envy-free equilibrium is an equilibrium where no advertiser has any incentive to swap positions with the advertiser right above him or her. Locally envy-free equilibrium is stable.

13 Locally envy-free Equilibrium 13 Advertiser Per-click Value BidPaymentPayoff Windows Mac Linux2200

14 A little history 14 Generalized First-Price Auction GoTo (now called Overture under Yahoo!) invented GFP auction in It probably marked the start of pay-per-click era of Internet advertising. VCG Auction It was first proposed by Vickery in I have not found any evidence suggesting it was used by any major search engine. Generalized Second-Price Auction GSP was first introduced by Google in Yahoo! switched to GSP soon after.

15 Why GSP, not VCG? VCG seems to be such an elegant mechanism. In fact, William Vickery won a Nobel Prize for it. GSP appeared first. So, it has the upper hand. VCG is hard to explain. Switching is expensive. Revenue prospects are uncertain. 15


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