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The Second-Price Auction in Action

When it comes to the Vickrey auction, also called the second-price auction, the way buyers bid is no mystery. The dominant strategy of bidders in this kind of auction is to bid their true value of the object. This way, if they are the highest bidder, they have a payoff once they pay the second highest price. This oh-so-easy strategy does not necessarily hold when more than one object is for sale. On the online blogging site CheapTalk, there is an intriguing post where a professor discusses this idea of the Vickrey auction and how it comes into play in the real world.

As a student in Economics 2040, I have learned the basics of a second-price auction (discussed above) and the dominant strategy of bidders.  However, we have not taken the time to think about the complexity of it in an actual situation. Sure, we can predict the strategies of buyers when there is a single item up for grabs, but when more items come to play our intuition about dominant strategy does not hold. Falling under the intuition of the Vickrey mechanism, Google advertisers made the same mistake when auctioning sponsored ads for keyword searches. In this kind of auction, all of the k highest bidders should be paying the same price: the k+1st highest bid. Although this is not what we would expect with our basic breadth of knowledge, the writer of this article makes an interesting point. Although such a huge company like Google could make such a mistake, their auctioning system worked out into a state of equilibrium since every bidder bid the same way—avoiding any chances of regret after the auction. In the end, it reduced to the Vickrey mechanism since all the highest bidders won.

The bidding strategies of second-price auctions can be more complicated than we realize. It was interesting and attention-grabbing to read about how something so simple that we learned in class can actually be an issue for a well-known company as big as Google. The little rules we learn three times a week about a simple one-item auction can actually be applied to the corporate world.


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September 2011