VCG PRICING
The Google ad auction is one way to auction off ad positions, but there are other ways that can be considered. One defect of the current auction is that each advertiser has to compare its incremental costs to its value, and those incremental costs depend on other bidders’ choices.
As it happens there is another auction-like mechanism that does not have this defect: the Vickrey-Clarke-Groves (VCG) mechanism (Varian, 2009). In the VCG mechanism: (1) each agent reports a value; (2) the search engine assigns agents to slots to maximize total value of the assignment; (3) each agent a then pays a charge equal to the total value accruing to the other agents if a is present minus the total value accruing to the other agents if a is absent. Thus each agent pays an amount equal to the cost that it imposes on the other agents.It can be shown that for this mechanism, each agent should report its true value, regardless of the reports of the other agents. Leonard (1983) was the first to apply this mechanism to the classic assignment problem. A few years later Demange and Gale (1985) showed that this mechanism results in the same payments as the minimum-revenue Nash equilibrium of a market equivalent to the second-price ad auction.7
There are other nice properties of the VCG auction. For example, Krishna and Perry (1998) show that the VCG mechanism maximizes the search engine’s revenue across all efficient mechanisms. Despite the apparent advantages of VCG, it has not as yet been deployed by any of the major search engines, though it is apparently being used for ad pricing by Facebook and Business.com.
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