1 Bringing the Dismal Science to Life: Lessons from Economic Experiments 2007 Capital Campus California Retreat January 19-20, 2007

2 Economists employ controlled experiments in building and testing theory. In an experiment, one tests for a specific response to a specific stimulus. In a simulation, one observes a suite of (sometimes unpredicted) auto-generated stimuli and responses. Economic simulations are useful for gaining intuitions into complex processes.

3 The purpose of this simulation is to create a competitive segmented market and to observe the market as it achieves equilibrium. In this simulation, you will experience real market forces. The same human traits and behaviors that govern real markets exist in the simulation. What are artificial are your surroundings. The market forces are real.

4 The Simulation The purpose is to simulate the manufacture of a product in a competitive environment. 1/3 of the players are manufacturers. Manufacturers use materials L and H to produce their product. 1/3 of the players sell material L to the manufacturers. 1/3 of the players sell material H to the manufacturers.

5 The Players and the Objects L Sellers = 1 unit of material L H Sellers = 1 unit of material H Manufacturers = 1 dollar= 50 cents (each)

6 Goals L Sellers  Sell your supply of L for as much as possible. Goal: End with as much money as you can. H Sellers  Sell your supply of H for as much as possible. Goal: End with as much money as you can. Manufacturers  Buy L and H. Use them to manufacture. Everything you manufacture is automatically sold for $1 each. Goal: Maximize your profit.

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8 Example Player L1 Sells 6 to Player 7 for $5 each. Player H4 Sells 8 to Player 7 for $5 each. Results Player L1 ends the simulation with (6)($5) = $30. Player H4 ends the simulation with (8)($5) = $40.

9 Example Player 7 manufactures 92 units of product that is automatically sold for $1 per unit. Result Player 7 ends with (92)($1) - $30 - $40 = $22 profit. 92

10 Trading Rules L Sellers and H Sellers must remain in their seats. L Sellers and H Sellers display cards indicating their ask prices. Manufacturers may only purchase 1 unit of L or H at a time.  Purchase the unit, take it to your seat, go back and purchase another unit, take it to your seat, etc.

11 These workers are better off by this much. These workers are worse off by this much.

12 Imposing a $3 minimum wage 1.Raised the wage rate for both categories of labor; 2.Decreased the wage difference between the categories of labor.

13 Imposing a $3 minimum wage 1.Created unemployment among the low skilled labor; 2.Had no significant effect on unemployment among the high skilled labor.

14 Imposing a $3 minimum wage 1.Reduced corporate profits;

15 Imposing a $3 minimum wage 2.Reduced production.

16 How does the simulation compare to reality?

17 Source: Bureau of Labor Statistics, California Department of Finance When looking at data, beware: 1.Correlation is not (necessarily) causality; 2.Outliers can skew results.

18 Source: Bureau of Labor Statistics, California Department of Finance R 2 =% of variation in the outcome variable (CA unemployment) that is explained by the explanatory variable (CA minimum wage). p=probability that any apparent relationship betweenthe explanatory and outcome variables is due to random chance as opposed to a true relationship.

19 Source: Bureau of Labor Statistics, California Department of Finance

20 Source: Statistical Abstract of the United States, and Bureau of Labor Statistics

21 Source: Statistical Abstract of the United States, and Bureau of Labor Statistics

22 Source: Statistical Abstract of the United States, and Bureau of Labor Statistics

23 Source: Bureau of Labor Statistics Minimum Wage as Percentage of Average Hourly Wage Unemployment Population Ratio for Year Olds as a Percentage of Ratio for Year Olds

24 Source: Bureau of Labor Statistics, California Department of Finance

25 Source: Bureau of Labor Statistics, California Department of Finance

26 Bringing the Dismal Science to Life: Lessons from Economic Experiments 2007 Capital Campus California Retreat January 19-20, 2007