International Journal of Industrial Organization, 25: 1163-1778
This paper describes how Google and other search engines sell Internet ads.
Online auctions show how prices evolve when it is very easy and cheap to experiment with different models.
- Search engines like Google use auctions to sell online ads. Internet advertisers bid on keywords used by users of search engines. When the keyword is used, the search engine shows an ad. The highest bids get the top positions on the page, where users are more likely to click.
- In “equilibrium” advertisers are content with the slots their bids have yielded, and no longer revise their bids to move up or down.
- There are a limited number of spaces on each page available, so some bidders are excluded. If a low bid, otherwise excluded, happens to succeed because a higher bidder drops out, the low bidder might unexpectedly profit.
- An auction is in a “locally envy-free” state in which no bidder would be better off if he traded places with the next higher bidder.
- The best bid for each bidder depends on what the other bidders have bid. Economists ask if there is a way to design an action so that the best bid depends only on how much.
- In the lower positions in a position auction, ongoing (incremental) costs decrease.
- If this were not true, a bidder would pass up cheap clicks to buy expensive ones.
- Bidders should bid more if moving up a position increases profits more than moving down saves on costs.
- Google ranks ads by a measures of ad quality—how likely users will be to click—as well as by bids. Advertisers can experiment easily online with different bids and different ads to find the best position, so they have nearly perfect information.
- A random sample of 2425 auctions with at least 5 ads each on one day shows that the value of one click is about a dollar, and the advertisers pay about 50 cents a click. Right-hand positions 1 and 2 are particularly desirable, perhaps because Google promotes them.
- Position auctions are similar to simple auctions.