1. Auction Theory תכנון מכרזים ומכירות פומביות Topic 7 – VCG mechanisms 1

2. Previously… We studied single-item auctions Bidders have values v i for an item A winning bidder gets a utility of u i =v i -p i – A losing bidder pays nothing and get u i =0 2

3. Previously… Seller possible goals: – Maximize social welfare (efficiency) 2nd-price (Vickrey) auction – Maximize revenue 2 nd -price auction with a reserve price (Myerson) – For example, reserve-price=1/2 for the unifom distribution on [0,1] – Reserve price is independent of the number of players. – Optimality assumes a technical assumption on the distributions. Revenue equivalence 3

4. Previously … We saw that in single-item auctions we can maximize efficiency with dominant strategies. Can this be achieved in other models? 4

5. Today This class: Moving from a specific example (single-item auctions) to a more general mechanism design setting. Main goal: in the presence of incomplete information, design the right incentives such that the efficient outcome will be chosen. 5

6. Outline 1.Some examples 2.VCG idea – intuition 3.Formal part: 1.Mechanism design model 2.The VCG mechanism 3.Proof: VCG is truthful 4.Roommates example 6

7. Auctions scheme v1v1 v2v2 v3v3 v4v4 b1b1 b2b2 b3b3 b4b4 valuesbids winner payments $$$

8. Mechanism Design scheme t1t1 t2t2 t3t3 t4t4 b1b1 b2b2 b3b3 b4b4 typesBids/reports outcome payments p 1,p 2,p 3,p 4 Social planner

9. Example 1: Roommates buy TV Consider two roommates who would like to buy a TV for their apartment. TV costs $100 They should decide: – Do they want to buy a TV together? – If so, how should they share the costs? 9 I only watch sports רק אירוויזיון !

10. Example 2: Selling multiple items Each bidder has a value of v i for an item. But now we have 5 items! – Each bidder want only one item. An efficient outcome: sell the items to the 5 bidders with the highest values. 10 $70$30$27$25 $12 $5 $2

11. Vickrey-Clarke-Groves (VCG) mechanisms Goal: implement the efficient outcome in dominant strategies. A general method to do this: VCG – 2 nd -price auction is a special case Solution (intuitively): players should pay the “damage” they impose on society. 11

12. VCG basic idea (cont.) In more details: You can maximize efficiency by: – Choosing the efficient outcome (given the bids) – Each player pays his “social cost” (how much his existence hurts the others). p i = 12 Welfare of the other players from the chosen outcome Optimal welfare (for the other players) if player i was not participating.

13. Vickrey-Clarke-Groves (VCG) mechanisms Let’s see how this payment rule works on our examples: 13 P i = Welfare of the other players from the chosen outcome Optimal welfare (for the other players) if player i was not participating.

14. VCG idea in single item auctions P i = 14 Welfare of the other players from the chosen outcome Optimal welfare (for the other players) if player i was not participating. = 0. When i wins, the total value of the other is 0. = 2 nd -highest value. When i is not playing, the welfare will be the second highest.  By VCG payments, winners pay the 2 nd -highest bid

15. VCG in 5-item auctions p i = 15 Welfare of the other players from the chosen outcome Optimal welfare (for the other players) if player i was not participating. $70$30$27$25 $12 $5 $2 =30+27+25+12. The other four winners. =30+27+25+12+5 The five winners when i is not playing. pays 5 pays ?? What is my VCG payment?

16. VCG in k-item auctions VCG rules for k-item auctions: – Highest k bids win. – Everyone pay the (k+1) st bid. And truthfulness is a dominant strategy here too. (we will prove it later) 16

17. Outline 1.Some examples 2.VCG idea – intuition  Formal part: 1.Mechanism design model 2.The VCG mechanism 3.Proof: VCG is truthful 1.VCG: the negative side 17

18. Mechanism Design scheme t1t1 t2t2 t3t3 t4t4 b1b1 b2b2 b3b3 b4b4 typesBids/reports outcome payments p 1,p 2,p 3,p 4 Social planner

19. Formal model n players possible outcome w 1,w 2,…,w m Each player has private info t i Each player has a value per each outcome (depends on t i ) – v i (t i,w) w is from {w 1,…,w m } Goal of social planner: choose w that maximizes 19 Single-item auction example: 2 players w 1 = “1 wins”, w 2 = “2 wins” t i =v i (willingness to pay) v 1 (v 1, w 1 ) = v 1 v 1 (v 1, w 2 ) = 0 Goal: choose a winner with the highest v i.

20. Formal model 20 w1w1 w2w2 w3w3 w4w4 w5w5 Player 1V 1 (t 1,w 1 )V 1 (t 1,w 2 )V 1 (t 1,w 3 )V 1 (t 1,w 4 )V(t 1,w 5 ) Player 2V 2 (t 2,w 1 )V 2 (t 2,w 2 )V 2 (t 2,w 3 )V 2 (t 2,w 4 )V 2 (t 2,w 5 ) Player 3V 3 (t 3,w 1 )V 3 (t 3,w 2 )V 3 (t 3,w 3 )V 3 (t 3,w 4 )V 3 (t 3,w 5 ) Player 4V 4 (t 4,w 1 )V 4 (t 4,w 2 )V 4 (t 4,w 3 )V 4 (t 4,w 4 )V 4 (t 4,w 5 ) Assume:w 5 maximizes efficiency w*=w 5

21. VCG – formal definition Bidders are asked to report their private values t i Terminology: (given the reported t i ’s) – w* outcome that maximizes the efficiency. – Let w* -i be the efficient outcome when i is not playing. 21 The VCG mechanism: – Outcome w* is chosen. – Each bidder pays: The total value for the other when player i is not participating The total value for the others when i participates

22. Truthfulness Theorem (Vickrey-Clarke-Groves): In the VCG mechanism, truth-telling is a dominant strategy for all players. 22 Conclusion: welfare maximization can always be achieved in dominant strategies. No Bayesian distributional assumptions. No real multiple-equilibria problem as in Nash. Very simple strategy for the bidders.

23. 23 Now, proof. We will show: no matter what the others are doing, lying about my type will not help me.

24. Truthfulness of VCG - Proof 24 The VCG mechanism: – Outcome w* is chosen. – Each bidder pays: Method of proof: we will assume that there is a profitable lie for some player I, and this will result in a contradiction.

25. Truthfulness of VCG - Proof 25 Buyer’s utility (when w* is chosen): Assume: bidder i reports a lie t’  outcome x is chosen. Buyer’s utility (when x is chosen):

26. Truthfulness of VCG - Proof 26 Buyer’s utility from truth (w* is chosen): Buyer’s utility from lying (x is chosen): Lying is good when: > Impossible since w* maximizes social welfare!

27. Truthfulness of VCG - intuition 27 The trick is actually quite simple: —By lying, players may be able to change the outcome. —But their utility depends not only on the outcome, but also on their payments. —With VCG payments, the utility of each player is the total efficiency.  Therefore, players want the efficient outcome to be chosen. Lying my ruin this.

28. The VCG family 28 From the proof, we can see that the VCG mechanism is actually a family of mechanisms. The VCG mechanism: – Outcome w* is chosen. – Each bidder pays: This could be any function of the other bids.

29. The VCG family 29 From the proof, we can see that the VCG mechanism is actually a family of mechanisms. The VCG mechanism: – Outcome w* is chosen. – Each bidder pays: Choosing ensures individual rationality (when values are positive) (the utility of each player is never negative, why?) and no positive transfers (players are not paid to participate, why?).

30. Single vs. Multi parameter We actually proved before how to implement the efficient outcome: – Max{v 1,….,v n } is a monotone function  we know how to construct mechanisms implementing it. What do VCG mechanisms add? But, this holds for very specific environments: players’ values are single parameter – That is, can be represented by a single real number (or more formally, an ordered space). – We needed the concept of “raising the value of a player” which implicitly implies an ordered space. The VCG mechanism is more general: multi- parameter domains. – Even if the private value consists of many values (as in multi-unit auctions). 30

31. Single vs. Multi parameter (cont.) What we learnt in previous classes holds for very specific environments: players’ values are single parameter – That is, can be represented by a single real number (or more formally, an ordered space). Even the interdependent/correlated models. – We needed the concept of “raising the value of a player” which implicitly implies an ordered space. The VCG mechanism is more general: multi-parameter domains. – Even if the private value consists of many values (as in multi-unit auctions). 31

32. Single vs. Multi parameter (cont.) From a mechanism design point of view, the difference between single- and multi parameter domains is huge: – The single parameter case is well-understood. efficient (Vickrey) auctions, optimal (Myerson) auctions, characterization of implementable social-choice functions. – Multi-parameter are mostly still an open problem For example, no-one knows what is the optimal (revenue maximal) auctions even for 2 bidders and 2 items. VCG is one of the few general results known for multi- dimensional domains. – But still, most real problems are multi dimensional. We will consider them in the coming classes. 32

33. Outline 1.Some examples 2.VCG idea – intuition 3.Formal part: 1.Mechanism design model 2.The VCG mechanism 3.Proof: VCG is truthful 4.Roommates example 33

34. Example 1: Roommates buy TV TV cost $100 Bidders are willing to pay v 1 and v 2 – Private information. VCG ensures: – Efficient outcome (buy if v1+v2>100) – Truthful revelation. In our model: Welfare when buying: v 1 +v 2 Welfare when not buying: 100 (saved the construction cost) 34

35. Example 1: Roommates buy TV Let’s compute VCG payments. Consider values v 1 =70, v 2 =80. – With player 1: value for the others is 80. – Without player 1: welfare is 100.  p 1 = 100-80=20 – Similarly: p 2 = 100-70 = 30 – Total payment received: 20+30 < 100 Cost is not covered! In general, p 1 =100-v 2, p 2 =100-v 1 p 1 +p 2 = 100-v 1 +100-v 2 = 100-(v 1 +v 2 -100) < 100 Whenever we build, cost is not covered. 35

36. Example 1: Roommates buy TV 36 Payment of agent 1 Payment of agent 2 70 80 0100 0 v1v1 v2v2 Needed to cover the cost

37. Example 1: Roommates buy TV Conclusion: in some cases, the VCG mechanism is not budget-balanced. (spends more than it collects from the players.) This is a real problem! There isn’t much we can do: It can be shown that there is no mechanism that is both efficient and budget balanced. – Even in simple settings: one seller and one buyer with private values. – “Myerson-Satterthwaite theorem” 37

38. Roommates (cont.) Now, assume that the values are v 1 =110, v 2 =130. How much each one pays (in VCG)? 0 Reason: agents do not affect the outcome Players that affect the outcome: pivots. Therefore, the VCG mechanism is also known as the pivot mechanism. 38

39. Context: Public goods The roommate problem is knows as the “public good” problem. Consider a government that wants to build a bridge. – When to build? If the total welfare is greater than the cost. – How the cost is shared? – Efficiency vs. Budget Balance (cannot achieve both). Another example: cable infrastructure. 39

40. More problems with VCG We saw one important flaw of VCG mechanisms: not budget balanced Other problems with VCG: – Auctions with externalities – Collusions – False name bids – Revenue monotonicity 40

41. Summary: VCG Maximizing efficiency is desired in various settings. We saw: one can always achieve this with (dominant-strategy) equilibrium. – “implementation” This is the only general goal that is known to be “implementable”. Pros: No distributional assumptions, strong equilibrium concept, individually rational. Cons: not budget balanced, prone to other manipulations. 41