Google auction mechanism – Why Google runs GSP auction to sell search ads.
In the video, Google’s chief economist, Hal Varian, provides a thorough and insightful overview of how the ad auction works. He describes how the auction system works so that consumers always see the most relevant ads and advertisers get the most value. It also provides an overview of key elements of Ad Rank: supply, quality and formats, and how it all works together to determine the position and the cost of your ad.
I have done some further research to understand why Google adopts such a method rather than others for its Ads auction. I start with a Second Price auction. Generally, a generalized second price auction (GSP) is used to sell multiple items in an auction to multiple bidders, where each item auctioned has a different value.
It works as follows
- Every interested buyer submits his or her bid for the item
- The buyer with the highest bid wins the auction and is selling the item at the price equal to the second highest bid.
This auction method has two very nice properties:
- It is true, i.e. It’s in the best interest of each buyer to bid the exact value of the item to him or her.
- It maximizes social welfare: the item is sold to the buyer who value it the most.