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Game Theory and the Design of Electronic Markets


Game Theory and the Design of Electronic Markets 

                  Sriharsha Hammika


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.



History of Game Theory 

  • John Von Neumann 1903 – 1957.
  • 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.


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


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


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.


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.


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


Uses of Game Theory 

  • Political Science
  • Economics and Business
  • Biology
  • Computer Science and Logic
  • Philosophy
  • Sociology
  • and many other fields



  • 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


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.


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.



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.




  • 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).



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




  • 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.


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.



  • 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.



  • 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.




  • 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.


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.




  • Google launched its AdWords Select program in 2000.
  • 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.



  • 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.



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.



  • 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).


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.



  • 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.



  • 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.

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