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Internet Advertising and the Generalized Second-Price Auction

This paper talks about a new auction mechanism, which we call the “generalized second-price” auction, or GSP. When an Internet user enters a search term (“query”) into a search engine, he gets back a page with results, containing both the links most relevant to the query and the sponsored links, i.e., paid advertisements. This means that advertisers target their ads based on search keywords. The paper gives us an example: if a travel agent buys the word “Hawaii,” then each time a user performs a search on this word, a link to the travel agent will appear on the search results page. When a user clicks on the sponsored link, he is sent to the advertiser’s Web page. The advertiser then pays the search engine for sending the user to its Web page, hence the name—“pay-per-click” pricing.

An ad shown at the top of a page is more likely to be clicked than an ad shown at the bottom. Hence, search engines need a system for allocating the positions to advertisers, so they came up with the GSP auction. In the simplest GSP auction, for a specific keyword, advertisers submit bids stating their maximum willingness to pay for a click. In particular, the ad with the highest bid is displayed at the top, the ad with the next highest bid is displayed in the second position, and so on. If a user subsequently clicks on an ad in position i, that advertiser is charged by the search engine an amount equal to the next highest bid, i.e., the bid of an advertiser in position (i + 1). If a search engine offered only one advertisement per result page, this mechanism would be equivalent to the standard second-price auction. Here, each advertiser pays the next highest advertiser’s bid.

I found this paper interesting to read because the GSP auction is similar to what we’ve learned in class about second-price auction, but not the same in that here bidding the true value is not a dominant strategy. For instance, there are three advertisers, with values per click of $10, $4, and $2, and two positions. However, the click-through rates of these positions are almost the same: the first position receives 200 clicks per hour, and the second one gets 199. If all players bid truthfully, then advertiser 1’s payoff is equal to ($10 – $4) * 200 = $1,200. If, instead, he shades his bid and bids only $3 per click, he will get the second position, and his payoff will be equal to ($10 – $2) * 199 = $1,592 > $1,200.

link to the paper: http://www.benedelman.org/publications/gsp-060801.pdf

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