Experimental economics

1
Experimental economics

• Mylene Lagarde, LSHTM
• Johannesburg, Nov 2007
• HEPNet Workshop

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Overview

• Background and characteristics of experimental
  economics
• Applications
• Classic use testing theories
• Recent developments social preferences
• Designing an experiment
• An example
• Main features of an experiment
• Some classic games
• Relevance for health systems research
• Possibilities and limitations of experimental
  economics

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1. Background and characteristics of experimental
economics
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Origins the willingness to test economic
assumptions

• Micro-economics relies heavily on a number of
  assumptions
• Preferences/mechanisms are hard to observe in
  natural environments
• Need to test and therefore potentially refute
  these assumptions in a scientific way?
• Market classroom experiment Chamberlain (1948)
  and his student V. Smith (1962)

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The influence of game theory

• Game theory attempts to model strategic
  interactions
• How do agents choose strategies which will
  maximize their return, given the strategies the
  other agents choose
• They use simplified structures for modeling
  strategic behavior
• Games provide a formal modelling approach to
  social situations in which decision makers
  interact with other agents
• Application to many problems
• Political science, economics, etc.

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Other major influences

• Psychology
• Psychologists have used experiments with
  participants to test some assumptions on
  fundamental behaviours authority
• Behavioural economics
• Informing economic theory with lessons from
  psychology
• Challenges neo-classic assumptions of economics
  (rationality, self-interest, stability of
  preferences, risk aversion, etc.)

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Principles of experimental economics

• To create an (economic) situation in a neutral
  environment (lab) which is
• real
• Real people
• participating for real monetary stakes
• following real rules
• simple
• controlled
• Motivations
• Initial information
• Interaction processes
• reproducible
• And observe behaviours and outcomes

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A method of empirical investigation

• Testing theories and establishing empirical
  regularities as a basis for new theories
• Elicitation of preferences attitude towards
  risk, fairness, altruism, trust, time preferences
• 3. Testing policies wind tunnel experiments

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A young and blossoming field
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The 2002 Nobel Prize in Economic Sciences
Vernon L. Smith
Daniel Kahneman
"for having established laboratory experiments as
a tool in empirical economic analysis, especially
in the study of alternative market mechanisms"
"for having integrated insights from
psychological research into economic science,
especially concerning human judgment and
decision-making under uncertainty"
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2. Some applications

• Classic use testing theories
• Recent development
• Field experiments
• Revealing social preferences

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Main areas of application

• Financial economics
• Information diffusion and aggregation, price
  setting mechanisms, irrationality, bubble
  formation
• Industrial economics
• Design of incentives and contracts (improving
  performance), auction designs (electricity
  markets, air slot allocation, etc.)
• Environmental economics
• Regulations to use common resources (fishery), to
  design pollution permit markets, etc. (public
  goods, externalities)
• Agricultural economics
• Real market experiments food auction, Actual WTP
  for cereals, etc.

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Main fields of research

• Individual choices
• inter-temporal choices, risk aversion, social
  preferences, etc.
• Strategic Interactions (game theoretic
  hypotheses)
• contracts, conflicts/coordination, public goods,
  etc.
• Industrial organization
• Market efficiency
• Market power issues (development of collusion,
  cooperation)
• Market design

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Testing theories

• Neoclassical theory works (relatively) well for
  markets where important assumptions hold (prop
  rights well defined, perfect information, low
  transactions costs)
• BUT not always.
• EE are simple tools which allow to
  isolate/measure the reasons for a models failure
• Models and principles that survive the testing
  can be used to address field questions

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Testing regulations/policies

• Financial markets
• Testing how to regulate markets to prevent
  irrational behaviour, the formation of bubbles,
  etc.
• Auction design
• Testing one predictions of models with real
  individuals in a controlled environment
• Environment economics
• How to regulate the use of rare resources
• Regulations and externalities (pollution permits,
  etc.)

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The spectrum of experiments

• Historically, EE has been applied in lab
  experiments
• Participants graduate students
• Computerized game or paper-based
• Neutral frame
• To test theories, policies
• Move lab games into the field a new practice
• Paper based
• Participants are not students, but real people
• Experiments are tailored to a field
  context/policy, and less neutral
• Experiments are used as tools to measure some
  values

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The importance of social preferences

• Social preferences
• preferences choices made by individuals ,
  tradeoffs btw different collections of things
  they value (time, money, prestige, leisure, etc.)
• social preferences how people rank different
  allocations of material benefits to themselves
  and others
• Existence and importance of social preferences
• Social preferences have an impact on the
  enforcement of social norms abundant literature
  on the effects of fairness, inequality (absence
  of), trust on economic behaviour, etc.
• Evidence of adverse effects of (monetary)
  incentives if social preferences not accounted
  for (voluntary work, intrinsic motivation)

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Revealing social preferences

• Difficult to identify them, even more to measure
  them
• How do you observe altruism ? Fairness ?
  Inequality aversion (relative to each other)?
  Risk aversion ?
• Why use experiments to measure them?
• Surveys on trust, altruism may be biased
• Experiments are likely to suffer less from
  response bias to reveal fundamental preferences
  because of monetary stakes
• Experiments allow quantification
• What types of preferences can experiments
  measure?
• Social preferences norms of altruism, fairness,
  trust, trustworthiness, aversion for inequity.
• Other preferences risk aversion, time
  preferences.

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Social preferences in 15 small scale societies (1)

• Henrich et al. (AER 2005, Science 2006)
• Setting project led by anthropologists, in 15
  remote societies on 4 continents

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Social preferences in 15 small scale societies (2)

• Objectives to investigate how social preferences
  vary across cultural environments
• Methods
• Measures of altruism, fairness and aversion for
  inequality
• Measures of market integration and other aspects
  of socio-economic life in these societies
• Results
• preferences are not exogenous (as assumed by
  neo-classic economics) but shaped by the economic
  and social interactions of everyday life
• Substantial variation among populations of
  aversion for inequality which co-evolves with
  norms of fairness/altruism
• the canonical model of the self-interested
  material payoff-maximizing actor is
  systematically violated

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Using EE to measure preferences (1)

• Karlan (AER 2005)
• Setting Peru, clients of a micro-credit program
• Objectives investigating the determinants of
  default payment and saving
• Methods
• uses survey and experimental measures of social
  capital -trustworthiness and willingness to
  cooperate
• Observes borrowing behaviour over 1.5 year
• Findings
• Significant negative correlation between
  (magnitude of) trustworthiness and (1)
  probability of default , (2) dropout of dropping
  out of the program and (3) volume of savings
• Some individuals are just not trustworthy and
  will not repay their loans?
• TG can be a valid measurement tool for
  trustworthiness, less obvious for trust which
  is too context specific

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Using EE to measure preferences (2)

• Carpenter and Seki (2006) and Carpenter and Seki
  (2004)
• Setting Japan, individuals involved in different
  degrees in fishing activities and are exposed to
  different degrees of competition
• Objectives
• to investigate the level of competition in a work
  environment can explain the propensity to
  cooperate
• to investigate whether the individual propensity
  to cooperate affects productivity
• Methods
• uses experimental measures of cooperation
• Uses surveys to measure productivity and level of
  competition
• Findings
• The higher the degree of competition the less
  cooperative individuals are
• The more cooperative individuals are, the higher
  their productivity

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A new but growing field

• Many other examples of games used to measure
  social preferences
• To see whether they help explain actual
  behaviours
• To use them as outcomes (e.g. impact of education
  program on altruism amongst children)
• Currently implemented in Mexico games
  piggy-backing on a national survey
• to provide new insights into the role of
  preference heterogeneity in explaining economic
  decisions and enable new tests of hypotheses that
  seek to explain family behaviour

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3. Designing an experiment

• Lets play a game !
• Main characteristics of the game
• Examples of other games

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Basic rules

• Please try to follow all the rules
• Listen and read carefully the instructions
• If you have questions, raise your hand and I will
  come and answer it privately
• Do not talk with each other, even when the
  experimenters are calculating the payoffs between
  rounds
• 100 ECU US 1

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Example with 3 players

• Players 1, 2 and 3 are given 200 ECU each
• Their decisions
• Player 1 invests 0 in A
• Player 2 invests 100 in A
• Player 3 invests 200 in A
• Return on investment from A 300 x 1.5450
• Return for all three players 450/3 150
• Endowments at the end of round 1
• Player 1 has 200 150 350
• Player 2 has 200 -100 150 250
• Player 1 has 200 -200 150 150

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Steps

• Write your ID number on your response sheet
• Write the amount you want to invest in A
• Detach the bottom section of your answer sheet,
  fold it and place it in the box
• Wait until you know the value of individual
  payoffs
• Calculate yourself the value of your endowment at
  the end of the round
• Play the next round

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Public good game interpretation and results

• Interpretation
• Propensity to cooperate (vs. free-ride) in a
  group, reciprocal behaviours in groups
• Use of different types of regulations (external,
  communication) in different contexts team
  compensation, cooperative production/maintenance,
  use of common resources
• Results
• Prediction each player will contribute nothing
  (individual welfare vs. collective welfare with
  public goods bringing externalities)
• One-shot game 50 contribution contributions
  diminish over time (final period
  contribution0)
• What contributes to increase cooperation
• Communication
• Possibility of individual punishment
• Disclosure of free-riding

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What would be different for real

• Smaller group
• Participants dont make their own calculations !
• You would be playing for real money
• Several treatments could be tested

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Game procedures (1)

• Abstract setting
• Anonymous players, playing once, for money,
  without communication
• Not lifelike, but baseline to observe effects of
  any variant (communication, non-anonymity, etc.)
• Participants
• college students recruited with minimal knowledge
  of the task (e.g. Study on decision making)
• More real people that you may want to observe
• Organization
• Ensure anonymity private box, random drawing
• Ensure credibility existence of recipients if
  not present, real incentives paid at the end
  DONT LIE

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Game procedures (2)

• Instructions to describe rules
• Plain abstract language (benchmark)
• Use letters/neutral framing
• Avoid some words sharing, helping, trust
• Examples, quiz
• Design characteristics
• Multiple rounds vs. One-shot games
• Depends on the game
• If equilibrium situation, then multiple rounds
  to allow learning (then rematching)
• Treatments vs. individual measurements

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Game procedures (3)

• Giving interactions to participants in
  multi-player games
• Direct feedback
• Strategy method players make choices
  conditional on every single response of other
  player
• Treatments
• Several groups 1 difference per group (rules,
  framing, etc.)
• Allows to measure the effect
• Not necessary if objective measurement of
  preferences for all individuals

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Components of an experiment

• Institution (rules of the game)
• Feasible actions
• Sequence of actions
• Information given
• Knowledge of participants
• Framing of instructions
• Abstract framing basic incentives only
• Framing matching reality to get at social norms
• Participation to maintenance of a water well
• Health worker, community, patient
• Interesting to compare abstract vs. real framing

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Experimental variables to define

• Procedural design
• Instructions
• Illustrative examples and tests of understanding
• Criteria for answering subjects questions
• Trial periods
• Experiment characteristics
• Payment
• Recruiting subject pool, number of subjects
• Matching procedures when interaction
• Environment
• Date and place
• Computerized or paper-based
• Irregularities which occurred

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Analysis of experiments

• Most analyses do not require sophisticated
  methods
• Measures of social preferences
• Creation of proxies based on individual choices
• Descriptive analysis at group level underlying
• Outcome variables under each treatment
• Influence of simple socio-economic variables

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A few examples of other games
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Dictator Game
PLAYER 1
PLAYER 2
measure of altruism
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DG - interpretation and results

• Interpretation
• Measure of altruism aversion for inequality
  (knowledge that the other is poor), etc.
• Relates to charitable giving
• Results
• Prediction no sharing BUT on average individuals
  give 20
• Allocations increase with needy/deserving
  recipients and decrease with anonymity
• Norms vary across settings/countries
• Game sensitive to setting, etc.

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Ultimatum Game
PLAYER 1
PLAYER 2
REFUSES Both get NOTHING
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UG interpretation and results

• Interpretation
• Measures of social norms of sanction
• Relates to pricing in a monopoly situation, or
  last minute settlement
• Results
• Prediction proposer sends the smallest possible
  unit (always accepted by recipient because better
  than nothing)
• On average proposers offer 30-50
• Offers below 20 are rejected half of the time
• Norms vary across settings and are well accepted
  (offers will be readily made according to norms)
• Effects of competition
• Btw proposers increases offers
• Btw recipients diminishes threshold of acceptance
• No effect of anonymity

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Third Party Punishment Game
PLAYER 1
PLAYER 2
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TPP interpretation and results

• Interpretation
• Behaviour of punisher Reveals aversion for
  inequality (against a shared norm) people who
  dislike it will take costly actions to reduce
  inequality
• Results
• Prediction No allocation from dictator
  observer never punishes dictator
• The less dictator allocates, the higher is the
  sanction

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Trust game
PLAYER 1
PLAYER 2
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Trust interpretation and results

• Interpretation
• Trust of investor and reciprocity of trustees
  (trustworthiness)
• Exchange of services without possibility to bind
  the second movers
• Results
• Prediction (expected) repayment from trustee 0
  and Entrusted/invested amount 0
• On average investors give 50, while trustees
  repay slightly less than that
• The bigger the investment, the bigger the
  repayment

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Bribery game
Other members of society
Private citizens
Expected cost of being punished/ caught
Expected cost of being punished/ caught cost of
producing the service
Public servants
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Results from bribery games

• Very few examples, different versions/level of
  complexity
• Barr and Serra
• Experiments on students coming from different
  countries
• positive correlation between internalized norms
  (Transparency international index) and corruption
  in the game
• Contradicts 1 other experiment

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4. Possible applications to health system issues

• Investigating corruption
• Revealing the influence of social preferences
• Health insurance
• Designing incentives, contracts, etc.

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Trust and trustworthiness

• Studies have emphasized the importance of trust
• In the workplace
• For patients towards health workers
• Experimental games could
• Provide a way to measure trust and
  trustworthiness in different framed contexts
• See how trusting behaviour differ when played
  with anonymous players/ nurses with doctors /
  doctors with themselves, etc.

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Experiments as measurement tools

• Quantification of social preferences
• altruism, aversion for inequity, trust, time
  preference, etc.
• Use the variables to test their association with
• health seeking behaviour (time preferences)
• Perceived quality of care (trust)
• Providers behaviours (different cooperative
  behaviours)
• Objective
• Descriptive
• Prescriptive link with other theories test new
  policies, etc.

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Health insurance

• When people are free to choose whether and how
  they secure their wellbeing, do they make
  predictable and rational decisions that are
  consistent with the objective of reducing
  vulnerability to health risks?
• Are there differences across individuals that can
  explain decisions to enroll/not enroll?
• Impact of time preferences on decision to enroll
  in a CBI ?
• Impact of risk aversion on propensity to enroll

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Investigating corruption

• Barr et al. (2004) the public servants dilemma
• Setting Ethiopia, nursing students
• Objectives
• to investigate the determinants of corrupt
  behaviour
• Methods
• uses a designed experiment with 3 types of
  players (monitor, health workers and community
  members)
• Findings
• Embezzlement of resources is affected by
• Earnings HWs (small effect)
• Observability of embezzlement behaviour and
  likelihood to be punished
• Legitimate monitoring (Election of a member of
  the community vs. random designation)
• Framing increases variance in behaviours
  suggesting different professional norms

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Plenty of other possible games !

• Games designed to reproduce an existing
  environment
• More complex, specifically designed/tailored
• Modelling choices faced by actors in a particular
  situation
• Reproduce incentives and main characteristics of
  these choices
• See which regulations may work better
• Objectives
• To better understand the determinants of
  behaviours

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5. Possibilities and limitations of experimental
economics

• What experiments can / cant do
• Advantages
• Limitations

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Experiments are one of many research tools

• Qualitative methods
• Surveys Econometric/statistical analysis of
  existing data
• Experimental methods
• Real-world pilots/trials
• Each has its relative strengths/weaknesses
• Complements, not substitutes

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When are experiments useful?

• To reveal or measure social preferences
  (altruism, trust, etc.)
• To understand behaviours/phenomena that can
  hardly be observed in the reality
• Measure (relative) values
• If the data dont exist, then create the data you
  need
• If its never been done, how do you know what
  works?
• Test new policies/ incentives / types of
  regulatory mechanisms
• Preliminary step, before actual pilot study in
  the field

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Advantages of Exp Econ (1) enhanced control

• It is known which variables are exogenous and
  which are endogenous
• Many variables that cannot be directly observed
  in the field can be observed in the lab.
• Quantification of reaction to incentives,
  cut-offs (risk aversion)
• Subjects are randomly assigned to the treatment
  conditions rules out selection bias.

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Advantages of Exp Econ (2)avoiding some biases

• Motivation (payment)
• avoid potential biases of responses obtained
  through classic survey instruments which can
  reflect a purchase of moral satisfaction
• Language
• neutral phrasing, avoid framing effects that
  influence answers
• Double blind
• Some designs allow complete anonymity and avoids
  experimenter effects and other-regarding concerns

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Example incentive program (P4P)

• Experiments could help understand
• Relative efficiency of different types of
  rewards/sanctions on an experimental outcome
• Design of incentive program
• individual or group-based and their impact on
  free-riding/gaming
• Impact of possibility to observe efforts or not

• Experiments could not answer
• Magnitude of effect on performance/quality of
  work, etc.
• Which value of incentive for a particular task
  (WTP, DCE)

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Example health insurance

• Experiments could help understand
• Time preferences of different groups of
  population
• Risk aversion of different types of populations
  regarding low and high probability events

• Experiments could not answer
• Which service package would
• Which value of premiums could be acceptable (WTP,
  DCE with service package as well)
• Which type of management (community based,
  facility-based, etc.)

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Limitations of Exp Econ

• Internal validity do the data permit causal
  inferences?
• a research study has internal validity if the
  outcome is a function of the variables that are
  measured/ controlled/ manipulated in the study
• Therefore internal validity of experiments is a
  question of proper experimental controls and
  correct data analysis.
• The method is not realistic and lack external
  validity
• A research study has external validity if the
  results obtained would apply to other similar
  programs or approaches.
• Problem of realism of abstract setting /
  simplistic modelling
• Problem of representativity/realism are
  experimental subjects representative for out of
  sample applications?

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Responses to lack of realism

• Most economic models are unrealistic in the sense
  that they leave out many aspects of reality to
  simplify it...
• Simplicity as a virtue?
• because it enhances our understanding of the
  interaction of relevant variables.
• Because it allows to get at underlying values/
  reflexes
• Whether realism is important depends on the
  purpose of the experiment.
• If testing a theory or understanding the failure
  of a theory, then the evidence is important for
  theory building but not for a direct
  understanding of reality.
• If EE is used to better understand real
  behaviours, then efforts must be made to frame
  the experiments and make them as close to real as
  possible

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Ethical issues

• Transparency of motives
• Even if not being deceptive, usually not honest
  about motives
• When deception is involved, potentially more
  serious.
• Inducing decisions
• The problem of the size of stakes / bribing
• Emotional distress
• subjects may learn something about themselves not
  like (selfishness, unacknowledged racist
  preferences)
• Even more problematic when not anonymous (to
  study effects of social norms)