auction data from Google and reports that lo-cally envy-free Nash equilibria “describe thebasic properties of the prices observed inGoogle’s ad auction reasonably accurately.”
I. The Structure and Evolution of SponsoredSearch Auctions
Notable Features of the Market for Internet Advertising
AcombinationoffeaturesmakesthemarketforInternet advertising unique. First, bids can bechanged at any time. An advertiser’s bid for aparticular keyword will apply every time that key-word is entered by a search engine user, until theadvertiser changes or withdraws the bid. For ex-ample, the advertiser with the second highest bidon a given keyword at some instant will be shownas the second sponsored link to a user searchingfor that keyword at that instant. The order of theads may be different next time a user searches forthat keyword, because the bids could havechanged in the meantime.
Second, search engines effectively sell ﬂowsof perishable advertising services rather thanstorable objects: if there are no ads for a partic-ular search term during some period of time, the“capacity” is wasted.Finally, unlike other centralized markets,where it is usually clear how to measure what isbeing sold, there is no “unit” of Internet adver-tisement that is natural from the points of viewof all involved parties. From the advertiser’sperspective, the relevant unit is the cost of at-tracting a customer who makes a purchase. Thiscorresponds most directly to a pricing model inwhich an advertiser pays only when a customeractually completes a transaction. From thesearch engine’s perspective, the relevant unit iswhat it collects in revenues every time a userperforms a search for a particular keyword. Thiscorresponds to a pricing model in which anadvertiser is charged every time its link isshown to a potential customer. “Pay-per-click”is a middle ground between the two models: theadvertiser pays every time a user clicks on thelink. All three payment models are widely usedon the Internet.
The speciﬁc sector of Internetadvertising that we study, sponsored search auc-tions, has converged to pay-per-click pricing.Since GSP evolved in the market for onlineadvertising, its rules reﬂect the environment’sunique characteristics. GSP insists that for eachkeyword, advertisers submit a single bid—eventhough several different items are for sale (dif-ferent advertising positions). GSP’s unusualone-bid requirement makes sense in this setting:the value of being in each position is propor-tional to the number of clicks associated withthat position; the beneﬁt of placing an ad in ahigher position is that the ad is clicked more,but the users who click on ads in differentpositions are assumed to have the same valuesto advertisers (e.g., the same purchase probabil-ities). Consequently, even though the GSP en-vironment is multi-object, buyer valuations canbe adequately represented by one-dimensionaltypes. For some advertisers, one bid per key-word may not be sufﬁciently expressive to fullyconvey preferences. For example, a single bidignores the possibility that users who click onposition 5 are somehow different from thosewho click on position 2; it does not allow for thepossibility that advertisers care about the allo-cation of other positions, and so on. Nonethe-less, these limitations are apparently not largeenough to justify added complexity in the bid-ding language. Nico Brooks (2004) ﬁnds onlymoderate differences in purchase probabilitieswhen ads are shown in different positions. Fol-lowing search engines’ approaches and Brooks’empirical ﬁndings, we likewise assume thevalue of a click is the same in all positions.
Varian discovered envy-free Nash equilibria indepen-dently and called them “Symmetric Nash Equilibria” in hispaper.
For manual bidding through online advertiser centers,both Google and Yahoo! allow advertisers to make unlim-ited changes. In contrast, the search engines impose restric-tions on the behavior of software bidding agents: e.g.,Yahoo! limits the number of times an advertiser can changehis bid in a given period of time.
A prominent example of “pay-per-transaction,” andeven “pay-per-dollar of revenue” (“revenue sharing”), isAmazon.com’s Associates Program, www.amazon.com/gp/ browse.html?&node
3435371 (accessed June 10, 2006).Under this program, a Web site that sends customers toAmazon.com receives a percentage of customers’ pur-chases. “Pay-per-impression” advertising, in the form of banner ads, remains popular on major Internet portals, suchas yahoo.com, msn.com, and aol.com.
244 THE AMERICAN ECONOMIC REVIEW MARCH 2007