Dynamic Model of Sponsored Search Advertising, A

Networks, the Internet, and Cloud Computing, Internet and Search and Advertising

Article Snapshot


Carl Mela and Song Yao


NET Institute Working Paper #08-16, September 2008


This paper looks at how firms like Google and Yahoo, online advertisers, and consumers interact online.

Policy Relevance

Billions of dollars annually are spent on sponsored search advertising; the model that this paper provides helps businesses and governments understand the utility of such advertising. Policy makers and business people that want to affect this billion dollar industry will benefit by reviewing this paper.

Main Points

  • The audience for online ads is growing, while the audience for television advertising shrinks.


  • When consumers type keywords into a search engine, it displays ads. The ad’s position on the page depends partly on how much the advertiser has bid for that keyword. Advertisers pay the search engine when consumers click on the ads.


  • Data from an anonymous search engine shows that advertisers value clicks about $.27 and bid $.20 on average. Products advertised are about $22, so advertisers expects 1.2% of clicks to become sales, a return of $.07 per click.


  • Consumers who click more prefer ads toward the top of the page; about 10% of consumers provide 90% of the clicks.


  • Tools that let consumers filter search results (e.g. by price) increases platform revenues 3.7% and consumer welfare by 5:6%, but lowers advertiser profits 4:1%.


  • Letting bidders target bidding to specific consumer demographics helps consumers (making it more likely that ads are useful), advertisers (by finding consumers more likely to buy), and search engines (by yielding more clicks) better off.
    • Competition between bidders for each keyword is less.
    • Search engines need not reveal demographic data to advertisers for all to benefit.


  • Google uses “second price” auctions; the bidder pays what the next bidder down has bid. In a “first price” auction, still used by some sites, the bidder pays what he bids. Second price auctions make advertisers more willing to bid what they would really pay, but have little effect on profits overall.


  • Increased competition between advertisers for keyword means higher bids. Higher priced products, new products, and highly rated products tend to yield higher bids.

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