Monday, January 18, 2010

Markets and Game theory

Two posts from Jeff Ely.

First: Why do we sit through movie previews in theaters? Because we will always arrive early because we want the best seats in the house (or at least, we don't want to be stuck in the worst seats).
In fact, even if the theater publicized the true start time we would still come early. The reason is that we are playing an all-pay auction bidding with our time for the best seats in the theater. Each of us decides at home how early to arrive trading off the cost of our time versus the probability of getting stuck in the front row. The “winner” of the auction is the person who arrives earliest, the prize is the best seat in the theater, and your bid is how early to arrive. It is “all pay” because even the loser pays his bid
Since we are going to get there early anyway, the theaters auction off our attention to advertisers and even if we dislike the previews, we are not willing to enough to make it worthwhile for the theatres to stop them
And this even explains why theater tickets are always general admission. Let’s compare the alternative. The theater knows we are “buying” our seats with our time. The theater could try to monetize that by charging higher prices for better seats. But it’s a basic principle of advertising that the amount we are willing to pay to avoid being advertised at is smaller than the amount advertisers are willing to pay to advertise to us. (That is why pay TV is practically non-existent.) So there is less money to be made selling us preferred seats than having us pay with our time and eyeballs.
Is this actually true? I thought we could now (at least in Mumbai) specify the seats we want when we buy movie tickets?

Second: why Google "handicaps" the most popular links when they auction off keywords.
Sponsored links are paid advertisements. They are sold using an auction that determines which advertisers will have their links displayed and in what order. While the broad rules behind this auction are public, google handicaps the auction by adjusting bids submitted by advertisers according to what google calls Quality Score. (Yahoo does something similar.)
Google does not really want the weaker, less popular advertisers to win, but by giving them an advantage, they force the stronger, more popular advertisers to bid more for their keywords.
The idea is based on the well-known principle of handicaps for weak bidders in auctions. Let’s say google is auctioning links for the keyword “books” and the bidders are plus a bunch of fringe sites. If Amazon is willing to bid a lot for the ad but the others are willing to bid just a little, an auction with a level playing-field would allow Amazon to win at a low price. In these cases google can raise its auction revenues by giving a handicap to the little guys. Effectively google subsidizes their bids making them stronger competitors and thereby forcing Amazon to bid higher

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