Experimental Economics

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Experimental Economics

• What is it?

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?

• How does experimental economics fit into
  economics?
• What are we testing in an experiment (discuss)?
• How does experimental economics compare to other
  experimental sciences?
• Physics
• psychology
• Experimental psychology
• Focus on cognitive process not choice and market
  outcomes
• Economists are interested in the effects of
  institutions
• Psychologists are interested in intrinsic
  behavior institution free
• Economists test theory, psychologists infer
  theory
• What is the relationship between experimental
  economics and behavioral economics?

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Emergence of Experimental Economics

• Key variables recognized by discipline must be
  amenable to experimental control
• Depends on current state of the underlying theory
• Micro economics virtually impossible to ensure
  that the abstract assumptions of optimization and
  equilibrium are met in the laboratory
• Emergence of new paradigms introduced new
  competing theories
• Walrasian general equilibrium competitive
  markets
• Strategic interaction Nash equilibrium and game
  theory

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Game theorists and gaming

• 1950s Princeton
• John Nash, Lloyd Shapley, John Milnor
• RAND corporation Santa Monica
• Conference Santa Monica 1952
• Jacob Marschak, Roy Radner, Herbert Simon
• Substantive and procedural rationality
• Use of math in social sciences

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Pioneers

• William Estes 1954
• Bernoulli choice experiments
• Convergence to true probabilities
• Probability matching
• No salient rewards
• Sidney Siegel
• Experimental design and procedures
• Boredom and lack of salience

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Germany

• Reinhard Selten
• Bounded rationality
• Not much published in english

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Vernon Smith and Charlie Plott

• Edward Chamberlin classroom markets at Harvard
• Poor support for competitive market solutions
• 1940s Vernon was a student of Chamberlins
  went to Purdue
• Double Auction institution with public
  information and stationary repetitions
• 1962 JPE
• Stanford 1961 influenced by Siegel
• Plott to Purdue 1960s Caltech 1971
• Fiorina and Plott committee decision making
  published 1978 (long publication lag)
• 1973-4 Smith visits Caltech
• 1975 Smith moves to Arizona Jim Cox, Arly
  Williams (PLATO)
• 2002 Nobel Prize Vernon Smith and Daniel Kahneman
• 1994 Reinhard Selten and John Harsanyi and John
  Nash

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Handbook Ch 1

• A Brief History of Experimental Economics
• The Uses of Experimentation
• Some Series of Experiments
• PD and public goods games
• Coordination
• Bargaining
• Competitive markets
• Auctions
• Individual choice

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A Brief History

• Early Experiments 1930-60
• Fitting indifference curves
• Test EUT
• Testing NE in PD games
• Testing competitive market hypothesis

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• Fitting indifference curves
• Thurstone (1931) Journal of Social Psychology
• Hats, coats, shoes, hypothetical, repetitions
• Rousseas and Hart (1951) JPE
• Bacon and eggs, between subject
• Test EUT
• Lottery choices
• Systematic violations Allais paradox (Allais
  1953 Econometrica

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• Testing NE in PD games
• PD games, Dresher and Flood (1950s), Nash on
  repeated games
• Kalisch, Milnor, Nash, and Nering (1954) Santa
  Monica conference volume
• Avoid repeated game designs
• Avoid symmetric payoffs that lead to fair
  divisions
• Schelling focal point theory
• Suppes and Atkinson, learning rather than
  equilibrium theories
• Testing competitive market hypothesis
• Chamberlin 1948 JPE bilateral search
• Induced values reservation prices
• Siegel and Fouraker (1960) bilateral monopoly
  bargaining information conditions
• Equal divisions and pareto optimality depend on
  information

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1960s to the Present

• A hundred experimental papers published in 1960s
• Appearance of review articles
• Vernon Smiths response to Chamberlin (1962)
• Becker deGroot Marshak (1964) incentive
  compatibility
• 1970s NSF support of some labs, Dan Newlon and
  Jim Blackmun

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Uses of experiments

• Speaking to Theorists
• Searching for Facts
• Whispering in the Ears of Princes

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Some Series of Experiments

• Prisoners Dilemmas and Public Goods Provisions
• Coordination Games
• Bargaining
• Markets and Competition
• Auctions
• Individual Choice
• What do theorists tell us?

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Prisoners Dilemma inefficient equilibria

• b gt a
• c gt d
• Confess not contribute
• Not confess contribute

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Findings

• Learn to cooperate
• Then learn the dangers of not defecting first
• Cooperation unravels over time
• Restarting game restarts cooperation in early
  rounds
• Kreps, Milgrom, Roberts, and Wilson (1982) JET
  Rational cooperation in the finitely repeated
  prisoners dilemma
• Axelrod tournament tit-for-tat

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Voluntary Contributions to Public Goods Free
Riding

• One-shot with homegrown values
• Bohm (1972) EER TV show
• Free riding is not a serious problem
• Induced values
• Emergence of free riding
• Mechanisms provision is sum of contributions, or
  auction mechanism where both contribution and
  quantity of public good is proposed
• Approx 50 of endowment contributed
• Repetitions
• Contributions deteriorate over time

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Coordination Games

• Multiple equilibria
• Cooper, DeJong, Forsythe, and Ross (1990) AER

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• Van Huyck, Battalio, and Beil (1990) AER
• Guessing game
• Guess a number between 1 and 7
• P0.6 (0.2m-0.1e)
• If everyone guesses 7 0.6 0.17 1.3
• If somebody else guesses 6 but I guess 7 0.6
  (0.26-0.17)0.61.2-0.71.1
• If I then switch to 6 also 0.6 0.161.2
• Game unravels in out of equilibrium play

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• Theoretically irrelevant factors matter (presence
  of dominated strategies)
• Theoretically important factors fail to show
  strong influence on equilibrium selection (Pareto
  dominance)

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Bargaining

• The core consists of many possible bargaining
  outcomes
• Nash axiomatic bargaining solution
• Nash equilibrium of a bargaining game
• Risk preferences matter
• Inducing risk neutrality through a binary lottery
  games
• Roth and Malouf (1979) Psychological Review
• Full or partial information about payoffs from
  tokens, symmetric or asymmetric payoffs
• Payoffs to other person matters
• Not predicted by theory
• Test of role of risk attitudes vs. information
  conditions
• Predicted effect of risk attitudes not found
• Is this due to small payoffs?

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Markets and Competition

• Chamberlin and Smith
• Double Auction market
• Convergence to equilibrium
• Asymmetric markets
• Distribution of surplus asymmetric
• Asymmetric market power in markets with many
  buyers and sellers
• Market power moves convergence away from
  competitive equilibrium

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Zero Intelligence Traders

• Gode and Sunder (1993) JPE
• Choose offer and bid randomly but constrained by
  non-negative profit requirement
• Convergence to equilibrium price and high levels
  of efficiency
• Properties of competitive markets are due to the
  profit constraint

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Market experiments with policy advice

• Hong and Plott (1982) Bell Journal of Economics
  (Rand Journal)
• Effects of price posting in barge operation
• Grether and Plott (1984) Economic Inquiry
• Effects of price posting in tetraethyl and
  tetramethyl lead markets
• Posting prices cause higher prices, smaller
  quantities, and lower efficiency
• Facilitate cooperation to raise prices

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Iowa Forecasting markets

• Forsythe, Nelson, Neumann, and Wright (1992)
• Asset trading in presidential candidates
• http//www.biz.uiowa.edu/iem/
• Traders purchase shares in candidates at fixed
  price
• Dividend is proportion of popular vote times the
  fixed price

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Auctions

• Common value auctions
• First price private value auctions
• Second price private value auctions

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Common Value Auctions

• Winners curse
• Object has common but uncertain value
• Bidders have private value signals
• Winning based on private value signal implies
  highest signal wins
• Loss since bid exceeds true common value
• Field data
• Oil field bidding
• Kagel and Levin (1986) AER
• Profits positive for small groups but negative
  for large ones
• Problem diminishes with experience and feedback

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Private value auctions

• First price
• Risk neutral vs. risk averse
• Payoff dominance, Harrison (1989) AER
• Second price
• Incentive compatible
• Kagel, Harstad and Levin (1987), Econometrica
• Over-bidding
• Earlier experiments showed under-bidding
• Restricted bids to be no higher than value

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Individual Choice

• Axioms of Expected Utility Theory
• Independence axiom
• Substitution axiom
• Reduction axiom
• Preference Reversals
• Choice and pricing task
• WTP-WTA disparity

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Preference Reversals

• P-bet .99 win 4, .01 lose 1 EV3.95
  VAR0.0895
• -bet .33 win 16, .67 lose 2 EV3.94
  VAR50.518
• P-bet chosen over -bet 50 of the time
• -bets are priced higher than P-bets when selling
  the bets
• BDM mechanism Becker DeGroot Marschak (1964)
  Behavioral Science
• Originally discovered in hypothetical setting,
  Grether and Plott (1979) AER used monetary payoffs

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Other anomalies

• Allais paradox
• Common ratio
• Common consequence
• WTA gt WTP
• Endowment effect, Kahneman, Knetsch, and Thaler
  (1990) JPE

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Preference elicitation

• Risk and time preferences
• Estimating parameters of utility functions
• EUT, Prospect Theory, Rank-Dependent Utility
  Theory
• Binswanger (1980) AJAE, farmers in India
• Heterogeneity in risk attitudes, but less so at
  higher stakes
• No wealth effect at higher stakes

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My research

• Public goods contributions and punishment
  mechanisms
• Are societies with punishment mechanisms
  desirable? Does desirability depend on ability to
  solve Free Rider problem or on profitability?
• Income distribution and reciprocity
• Do people have a taste for equality in income
  distribution are they willing to give up their
  own money?
• Do people display a taste for reciprocity after
  some common history of negative externality game?
• Rent seeking
• When taxes and subsidies are endogeneous will
  subjects engage in costly rent seeking activies?
• Learning and belief elicitation in interactive
  games
• Value elicitation
• Extent of hypothetical bias
• Calibrating hypothetical bias
• Comparison of instruments for elicitation
  valuations
• Elicitation of risk and time preferences
• Denmark field subjects
• Virtual experiments