Experimental Economics Professor Avi Weiss

Introduction Six Steps (Charles R. Plott) Step 1 - We learned how to pose a question –At first, economic questions were about economies “in the wild” – not appropriate for experimental study –Shift from study of economies to study of theories, models and principles General theories must apply to simple special cases These can be created in lab Use these simple economies to test and evaluate predictive capabilities of general theories when applied to special cases

Models of economies are general involving principles intended to have applicability independent of time and location There are a “staggeringly” large number of theories –Experiments are meant to weed out the ones that don’t work in even simple cases –Improve models so it can work in simple cases “The trick is to notice that economies created in the laboratories might be very simple relative to those found in nature, but they are just as real. Real people motivated by real money make real decisions, real mistakes and suffer real frustrations and delights because of their real talents and real limitations.”

The laboratories are simple, which allows the reasons for a model’s failure to be isolated and perhaps measured. Models and principles that survive the testing can be used to address field questions

Step 2 – Some important discoveries were made Chamberlin – first study of supply and demand Power of Nash equilibrium. Early studies of institutions Vernon Smith – supply and demand in double auction model. Concept of efficiencies –Can compare different setups –Institutions (Posted prices)

Step 3 – Economic Theory Advanced Informational economics Bargaining and Non-cooperative Game Theory –Slight changes in institutional form can have dramatic impact on predicted outcome –Rationality and common knowledge –Models used in applications so sensitive to assumptions and institutions, that field test became hopeless –Labs ideal for such testing

Step 4 – Laboratory Data Suggest Theory on Right Track Double auction markets Rational expectations Sealed bid auctions “The data strongly suggest the existence of uniformity of behavior in complicated, competitive environments and that theory is on the right track”

Step 5 – Paradoxes Begin to Appear Winner’s curse –Change from private values to common values Posted prices vs. double auctions Centipede experiments Ultimatum game Bubbles in asset markets

Step 6 – Say’s Law Supply creates its own demand Experiments yield interesting results Generates research questions that can only be answered by additional experimentation –Stress tests

Individual Choice Experiments Market Experiments Game Experiments

Benefits of Experimental Economics Replicability Control If theory doesn’t work under ideal conditions in the lab, it will certainly not work in reality Communication between theorists and experimentalists (particularly in game theory experiments) Can be used in litigation to shift burden of proof

Tests of behavioral hypotheses Theory stress tests Search for empirical regularities (measurement without theory?)

In standard experimental paper must report: –Instructions –Illustrative examples and tests of understanding –Criteria for answering subjects’ questions –Payment –Trial periods –Recruiting, subject pool –Number of subjects and experience –Matching procedures –Date and place –Environment (computerized?) –Deception? –Irregularities which occurred

Motivation (payment) Unbiasedness – language, double blind Calibration – compare with other theories Design parallelism – reality check

Problems with experimental economics Non-realistic Insufficient incentives (Harrison criticism) Subjects not sophisticated enough