Lecture 2Hayek Hypothesis and Institution as a Variable "Markets as Economizers of Information: Experimental Examination of the ‘Hayek Hypothesis’," Economic Inquiry

Markets as Economizers of Information: Experimental Examination of the ‘Hayek Hypothesis’, Smith EI 1982 Static Competitive Equilibrium Theory -A reallocation of resources from an initial endowment, the exhaust gains from exchange (Pareto Optimal) -There does not exist a coalition that can better themselves by deviating from the final allocation and trading amongst themselves from initial endowments (core) -The is a price system such that all agents are maximizing there utility subject to budget constraints and there is no excess demand in any market. (CE)

Hayek Hypothesis Under what circumstances can we expect a CE to arise? Hayek Hypothesis: strict privacy together with the trading rules of a market institution (the oral double auction in this case) is sufficient to produce efficient competitive market outcomes. Price Taking Hypothesis: The number of buyers and sellers are so large that each individual has imperceptible influence on price Common Knowledge Hypothesis: Perfectly foreseen conditions of supply and demand

Market experiment: the institution issue Chamberlin 1948 first market experiment – Decentralized negotiation as a "souk" – Inefficient outcomes compare to partial equilibrium prediction Smith 1962 answer – Market institution matter – Continuous oral double auction as centralized stock exchange – Efficient outcome with a quick convergence to the partial equilibrium even with small number of traders

Double Auction-Induced S&D Test of the Hayek Hypothese Let’s write on the board the elements of environment. Now Let’s describe the instituion What is the theoretical benchmark? What are the treatment variables implied by the three hypothesis? Let’s look at our data

Smith results on Stationary Environments Large Numbers not necessary Robust to extreme environments

Intertemporal Demand and Environment Shocks Demand Cycle Db and Dy Two traders who can buy and resell commodities

No storage and demand cycles

Our Long Run Experiment

Posted Offer Environment NE for design II P=(.05,.06,.08) Q =(5,4,0)

Posted Offer Institution – Specify on the board the institution of the PO institution – Let’s look at our results – What about tacit collusion?

Elements of the Institution Agent i’s property rights in communication and exchange I i =(M i, h i (m), c i (m), g i (t 0, t, T)). A Microeconomic Institution is the collection of individual property rights. I i =(I 1, I 2,…., I N )