While Google offers most of its innovative and useful products for free, it still makes incredible amounts of money.  The company survives on money gained from advertising; the money Google receives from clients who advertise on their sites makes up the vast majority of the company’s revenue.  Needless to say, Google’s process for fairly determining advertising space for their clients is central to its success, and the author of this Wired article (http://www.wired.com/culture/culturereviews/magazine/17-06/nep_googlenomics?currentPage=1), Steven Levy, has dubbed their advertising-heavy revenue model “Googlenomics.”  The article examines how Google uses an auction system to allocate advertising space.

AdWords, Google’s way of selling online advertising slots, is an auction system.  When you do a Google search, “sponsored links” appear on the search results page with advertisements relevant to your search.  The article explains how different advertisers claim these slots:  Google uses a “Generalized Second Price auction model,” just like the “second-price sealed-bid auction” discussed in class.  Advertisers submit bids on search terms – they submit the amount they would be willing to pay ever time their ad was clicked on by a searcher.  They simultaneously submit them, so the bids are “sealed” to the other bidders.  For a single search, all the slots on the side of the page are filled in one auction, starting with the highest bidder and continuing to the lowest further down on the page.

The author writes that Google reasoned their way into a second-price auction instead of an “all-at-once” auction because of their fear that advertisers would submit unreasonably low bids so they could avoid paying much more than the advertiser in the slot directly below them.  So Google implemented a second-price auction, where the auction winner with the highest bid wouldn’t pay the bid he placed, but instead one penny more than the next-highest bid.  The next-highest bid pays one penny more than the next-highest bid below him, and continues until the slots are filled.  This way, the bidders didn’t have to worry about overbidding, making all of the overall bids higher and making more money for Google.

Google’s second-price auction is an interesting application of the second-price auction we learned about in class, because it allows not just for a winner, but also for second, third, fourth, etc. place winners who keep paying the lower bidders’ prices.  In the book and in class, we often treated the winner as the only winner and the losers receiving no payoff, while in Google’s model the top 10 or so bids all receive a payoff of an ad slot, but the better bids receive better slots.

I think this is a great example of when an auction should be used:  the advertisers don’t know how much value each other advertiser will place on specific search terms, so they assess their own value of getting a good advertisement slot and make a blind bid.  It also splits advertisers up into categories based on which search terms they value the most.  For internet searches that happen hundreds of thousands of times a minute, Google has found a way to fairly allocate advertising space by making each search the start of a new auction, giving many advertisers, large and small, a fair chance at having their advertisement displayed in a desirable location on a Google search result.