1. Economics 430/530 EXPERIMENTAL ECONOMICS Spring 2012
Seda Ertac
Koc University

2. Introduction This Class: What is an experiment?
Brief history of experimental economics
Behavioral vs. experimental economics
Main types of topics studied through experiments
Next Few Classes: The methodology of experiments.

3. Experiments and Econ
One possible way of figuring out economic laws ... is by controlled experiments. ... Economists (unfortunately )... cannot perform the controlled experiments of chemists or biologists because they cannot easily control other important factors. Like astronomers or meteorologists, they generally must be content largely to observe.” (Samuelson and Nordhaus, Principles of Economics, 1985, p. 8)

4. Experiments and Econ
Experimental economics is an “exciting new development”.
-Samuelson and Nordhaus, Principles of Economics, 14th Edition, 1992, p.5

5. .

6. What is an experiment?
An experiment is a replicable observation of a phenomenon under controlled conditions. “Control”=>The essence of experimental methodology (Smith, 1972). We want to: isolate the effect of variables of interest, keeping other things constant.

7. What is an economics experiment?
We collect our own data on individuals’ behavior to answer an economic question. Why? Sometimes, we don’t have “good” data in the field. Sometimes we want to test some theory: e.g. Does “competitive equilibrium” work? How do people behave in a prisoners’ dilemma? What is the observed equilibrium?

8. Economics
Theory (Models of how individuals behave in economic situations, predictions of what outcomes are observed)
Naturally-occurring (field) data (e.g. GDP, prices, school enrollments, wages etc.)
Experimental data
A) Laboratory experiments
B) Field experiments

9. Types of Experiments Laboratory Experiments -On student subjects
Field Experiments
-Different subject pool, natural context etc.

10. Behavioral Economics
Incorporates psychological insights into economic models. For example, in economics we traditionally assume that people are rational, selfish, maximize expected utility.

11. What if people are overconfident?
What if people are time-inconsistent?
What if people’s utility depends on others’ payoffs?
How do we know=>Experiments
Behavioral economicsExperimental Economics

12. Nobel Prize in Economics, 2002 Daniel Kahneman (for behavioral), Vernon Smith (for experimental)

13. The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel 2002
Vernon Smith: “for the use of laboratory experiments as a tool in empirical economic analysis, in particular, for the study of different market mechanisms”. Founder of experimental economics.
Daniel Kahneman: “for the introduction of insights from psychological research into economics, in particular with regard to judgements and decisions under uncertainty”. Kahneman’s research is based on psychological experiments and questionnaires. Founder of behavioral economics.

14. Behavioral Economics, Experimental Economics
Psychology
Behavioral Economics, Experimental Economics +
Neuroscience =
Neuroeconomics

15. Example of MRI scanner Scanner a very powerful electro-magnet
field strength of 3 teslas (T), ~60,000 times greater than the Earth’s field
During the experiment:
subject lies in the scanner and is exposed to the stimuli
scanner tracks the signal throughout the brain 15

16. Ultimatum games: This is your brain on unfairness (Sanfey, Rilling et al, Sci 13 March ’03)
Insula: negative emotional states, ACC detection of conflicts;
DLPFC: cognitive process: goal maintenance, executive control

17. Topics & History Chamberlin (1948)—market experiments Vernon Smith…
Game theoretic experiments (e.g. see if people cooperate in a prisoners’ dilemma)
Main Topics Studied Through Experiments
Individual decision-making experiments
Game theoretic experiments
Market experiments

18. Why Experiments?
Field data can be hard to interpret (e.g. selection bias, many factors change simultaneously, have to use complicated econometrics)
e.g. supply/demand data
Field data may not even exist (e.g. beliefs, reservation wages/outside options of workers, valuations that people place on goods).

19. With experiments, we can:
Help economic theorists
Gather new facts
Help/influence policy-makers
(Examples)
Simpler statistical analysis
Replicability and control

23. Advantages of (Lab) Experiments – Enhanced Control
Subjects are randomly assigned to the treatment conditions – rules out selection bias.
It is known which variables are exogenous and which are endogenous – allows to make causal inferences.
Experimenter can make ceteris paribus changes in the exogenous variables – allows for the isolation of true causes.
Many variables that cannot be directly observed in the field can be observed in the lab.

24. Advantages of (Lab) Experiments – Enhanced Control
Information conditions and exogenous stochastic processes and factors can be controlled.
Important for the testing of models with asymmetric information.
Better direct controls reduces the need for complicated econometric methods.
Replicability – provides the basis for statistical tests. Critics can run their own experiments.

25. Advantages of (Lab) Experiments – Enhanced Control
Enhanced control opportunities often imply that the experimenter knows the predicted equilibrium exactly.
Equilibrium and disequilibrium actions can be explicitly observed.
Quick or sticky adjustment can be explicitly observed
Example: What are the supply and demand schedules that underlie observable price & quantity data? Is the observed price-quantity combination a competitive equilibrium?

26. Economics vs. Psychology
Many common areas of interest (e.g. judgment and decision-making), but very different methodological practices. Economics: 1.Salient monetary rewards (vs. participation fee only). 2.Context-free to the extent possible.(*) 3.No deception!!!