dominant strategy is to bid its true reservation price. For instance, if you believe a
Persian rug up for bid is worth $800, this is exactly what you should bid. If yours
is the highest bid and $620 is the next highest bid, you win the rug at a price
of $620. It doesn’t pay to shade your bid below your true value because doing
so does not affect the price you pay when you win. (In fact, if you were per-
suaded to bid $720, you would be fortunate to still win, but the price of $620
wouldn’t change. However, foolishly lowering your bid would be a disaster if the
next-highest bid were $750, causing you to lose the rug altogether.)
Although they appear to be quite different, the English and Vickrey auc-
tions are strategically equivalent when bidders hold private values. To see this,
imagine that everybuyer in an English auction were to authorize a personal
representative to bid on his behalf. (For instance, this is routinely done if the
buyer cannot be present at the auction.) Each buyer privately submits its reser-
vation price to this representative, instructing him to bid up to this value if nec-
essary. (In fact, each buyer should always submit his truereservation price.)
Once all bids are reported, the auction house could hold a “virtual” English
auction. It simply identifies the two highest submissions, “bids” them against
one another, until the price just matches the second-highest submission
(whereupon this bidder is dropped from the auction), and thereby awards the
item to the high bidder at the second-highest bid price (and this corresponds
to the second highest reservation price). Thus, the final prices in the Vickrey
and English auctions are identical: P2ndPEv2nd.Google dominates the online search market, from which it generates more than
$30 billion in annual revenues in the form of online advertising. When a user
searches for a keyword (such as “Hawaii”), relevant links appear as well as up to
11 sponsored links, that is, paid advertisements, listed from top to bottom in a col-
umn on the right-hand side of the Web page. An Internet seller has paid Google
for a particular sponsored link attached to a specific keyword. How was the spon-
sored link sold? Via an automated auction—indeed, new bids are submitted to
Google continually for thousands of keywords, minute by minute.^4
Google’s online ads were not always sold this way. Before 2002, its top-of-
Web page ads were sold the old-fashioned way—by a human sales force pursu-
ing clients and negotiating prices. Clients were charged whenever a user called
up the Web page showing the ad, whether or not the user actually clicked on
it. But top management soon realized that selling online ads this way was too
limited, too labor intensive and slow, and (most important) too uncertain as to
what the right price should be. Google took what was a huge risk at the time;
it phased out its ad sales force that had been pushing campaigns worth hun-
dreds of thousands of dollars in fees in favor of automated ad auctions paying
Google mere pennies per clicks on its sponsored links. Top management did
the math; millions of clicks per hour (across thousands of keywords) added up
to billions of dollars per year.Auctioning
Google’s
Online Ads(^4) This account is based on B. Edelman, M. Ostrovsky, and M. Schwarz, “Internet Advertising and the
Generalized Second-Price Auction: Selling Billions of Dollars’ Worth of Keywords,” American
Economic Review(March 2007): 242–259; and S Levy. “Secret of Googlenomics: Data-Fueled Recipe
Brews Profitability,” Wired Magazine, May 22, 2009.
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