Paid Placement: Advertising and Search on the Internet

Paid placement, where advertisers bid payments to a search engine to have their products displayed prominently among the results of a keyword search, has emerged as a predominant form of advertising on the Internet. This article studies a model of product differentiation in which the auction of advertisement positions is embedded in a market game of consumer search. In equilibrium, more relevant sellers for a given keyword bid more and their paid placement by the search engine reveals information about the relevance of their products. This results in efficient sequential search by consumers and increases total output. We also find that the search engine's revenue may have an inverted U-shape with respect to the match probability of the most relevant seller.