1 Game Theory and the Design of Electronic Markets Sriharsha Hammika

2 Game Theory!!! Game Theory is not about the usual computer games. Game theory is the study of decision making among multiple agents (human or software). Decisions are made in order to maximize the returns. In a game the decision of all agents jointly determine the outcome. Agents may be individuals, groups, firms or any combination of these.

3 History of Game Theory John Von Neumann 1903 – Book - Theory of Games and Economic Behavior. John Forbes Nash 1928 – Popularized Game Theory with his Nash Equilibrium (won Noble prize). A Beautiful Mind movie.

4 Game Theory Games are well-defined mathematical models. Game consists of a set of players and a set of moves. Types of Games:  Symmetric and Asymmetric  Zero sum and non-zero sum  Simultaneous and sequential  Perfect Information and imperfect information  Infinitely long games

5 Types of Games Symmetric  Payoffs for a particular strategy depend only on other strategies employed.  Payoffs do not depend on the person playing the game.  Chicken, Prisoners dilemma Asymmetric  No identical strategy set for both the players  Payoffs depend on the person playing the game

6 Types of Games Zero sum  Special case of constant sum games.  Choices by players can neither increase nor decrease the available resources.  Poker Non-zero sum  Most of the games studied by game theorists are non-zero sum.  Some outcomes have net results greater than or less than zero.

7 Types of Games Simultaneous  Both players move simultaneously  Later player is not aware of earlier players actions Sequential  Also called as dynamic games  Players have knowledge (maybe little) about other players actions.

8 Types of Games Perfect Information  All players know the moves previously made by all other players.  Only sequential games can be games of perfect information  Chess Imperfect Information  Players do not know the previous moves of other players

9 Uses of Game Theory Political Science Economics and Business Biology Computer Science and Logic Philosophy Sociology and many other fields

10 Auctions An Auction is the process of buying and selling things by offering them up for bid, taking bids and then selling it to the highest bidder. Can be of two types:  Reserve Auctions Minimum reserve amount  Absolute Auctions No reserve amount

11 Primary Types of Auctions English Auction  Used in English Auction Houses.  Participants bid openly against each other.  Usually has a reserve prize.  Auctioned till a buy-out price is reached. Dutch Auction  Auctioneer begins with a high asking price.  Price lowered until some participant is willing to accept the price.

12 Few more types of Auctions Sealed bid first price auction  Also known as Sealed High-Bid auction  First-Price Sealed Bid Auction ( FPSB ).  All bidders submit bids simultaneously.  Closed bidding. Sealed bid second price auction  Also known as Vickery Auction.  Similar to FPSB Auction.  Winning bidder pays the second highest bid.

13 Electronic Consumer Auctions Important feature of electronic commerce. Auctions made online and electronically. Amazon, eBay and any online bidding websites. High revenues made by these auctions.

14 eBay Electronic Auction house Founded on September 3, 1995 by programmer Pierre Omidyar as Auction Web. Ascending auction which terminates at a fixed time. Proxy Bidders are used. Willingness to Pay (WTP).

15 Problem of Sniping in eBay Sniping is a disadvantage of eBay bidding strategy. Manual bidders act as snipers. eBay will increase your amount till it reaches the WTP. What if all the bidders were snipers??? The auction would become similar to sealed – bid auctions

16 Amazon Implements the going, going, gone feature of live auctions. Whenever a bid is cast in the last 10 minutes then the bid is extended by another 10 minutes. Sniping is prevented. Amazon – style auctions have been observed to be more efficient.

17 Sponsored Search Auctions Search engines sell keywords. Before internet the advertising pricing model was based on cost per thousand impressions ( CPM ). This model well suited to more traditional media such as television, newspapers and magazines.

18 Yahoo! In 1997, Overture (now Yahoo Search Marketing) launched an innovative framework. The major features are:  Each keyword was sold via its own auction (prices were as low as <$1 for a single slot).  Payment is made on a pay-per-click (PPC) rather than a per-impression basis.

19 Yahoo! Many inexpensive, perishable goods – namely keywords for searches were auctioned. Many positions for the keyword were auctioned. Positions at the top of the page were auctioned for more.

20 Yahoo! The mechanism has been characterized as generalized first – price auction (GFP ). Highest bidder wins the first slot followed by the second highest bidder for the next slot and so on. The major disadvantage of Overture (Yahoo’s) auction design was the winning bids were posted. This resulted in instability.

21 Instability in Overture design Three bidders A,B,C bidding for three slots. A wins for WTP(A) followed by B then by C. B realizes that only C+& would be sufficient to win slot two and lowers the bid. A realizes that only C+2& would be sufficient to win slot one and lowers the bid. Now, B can increase the bid to C+3& to win slot one and A increases his bid This situation continues until B reaches his WTP and then he lowers back to C+& and the cycle begins again.

22 Google Google launched its AdWords Select program in Google uses Generalized second – price auction (GSP) mechanism. The highest bidder wins the first slot but pays the second highest amount for the first slot. This reduces the instability problem of the GFP auction.

23 AdWords Pay Per Click (PPC) instead of CPM. The advertising slots are allocated in the decreasing order of revenue rather than decreasing order of bids. Revenue is calculated based on the advertiser’s bid amount, expected click – through rate.

24 Trading Agent Competition Annual Competition hosted by Association for Trading Agent Research. TAC provides means of evaluating and comparing research methods in agent based online bidding. Software agents are rapidly replacing humans in online auctions. Advantages of using Agents:  Systematically monitor a wide variety of auctions.  Make rapid decisions about bidding.  Can do this continuously and repetitively without losing concentration.

25 TAC Purpose of TAC:  Evaluate agent strategies in a simulated electronic market.  Evaluate market designs, given a group of trading agents. Two running versions of TAC are  TAC Travel  TAC Supply Chain Management (SCM).

26 TAC Travel Travel goods (flights, hotels and entertainment tickets) are sold. Each agent acts on behalf of one of the clients and bids as per the clients preferences.

27 TAC SCM Was designed to capture many of the challenges involved in supporting dynamic supply chain practices. Agents buy raw materials from suppliers and sell finished goods to customers.

28 Conclusion Electronic commerce promises to reshape the world’s economy. A lot of research is being made in the field of Algorithmic Game Theory. Electronic market mechanisms should be evaluated based on game theory prior to their release. Also called as Computational Mechanism design as it overlaps with both game theory and computer science. Better market designs will do a better job of matching buyers and sellers, ultimately enhancing the welfare of the society.