Can anyone please explain, How does automated auction allow price discovery?
Price discovery is the main function of an exchange, electronic or not. For an example (outside of CFA curriculum), you may refer to the process of producing an opening price on electronic exchanges. The matching engine produces a price based on combination of Limit Buy and Sell orders submitted prior to the open. Basically it sets such an opening price that maximizes the volume of executed orders. Prior to the open it produces an indicative price, without actually matching any orders. I.e. a pure price discovery mode based on auction orders.