1. Experimental Research in Social Sciences: Economics
Shyam Sunder. Yale University
Conference on Social Science Research: Issues, Challenges and Strategies
Institute of Public Enterprise, Hyderabad, India
January 10-11, 2013

2. An Overview
Economics shares the challenges before other social sciences in identifying universal, replicable, stable laws that have significant predictive content in order to justify the endeavor as a science
I shall use this limited time to give two examples of research which has succeeded in identifying such laws.
If time permits, I shall touch on some major challenges before us

3. Economics as an Experimental Science
Only a little over half-a-century old
Experimental method is valued for allowing manipulative control over conditions of observation, repeatability, and predictive power at expense of some external validity (to overcome self-selection problems of field data)
In the panel session I mentioned three challenges facing social sciences: transience, robustness and ethical
Social sciences’ object of interest are sentient beings (awareness, learning, willful reaction to treatments): difficulty of finding universal laws
Questions about robustness of any discovered “laws” to their own discovery
Difficulty/ethics of manipulative control, e.g., in legislation, macroeconomics, race relations (but also in astronomy, geology, and meteorology)
Focusing attention on aggregate level (market) phenomena which may be less susceptible to the first two problems (drawing a crude boundary between psychology and economics)

4. Properties of competitive markets
Vernon Smith (JPE 1962)
22 student traders (11 buyers and 11 sellers
Double auction (both sides can propose prices; bids or asks)
Price improvement rule (higher bids and lower asks count)
Profit
Value – price for buyers
Price – cost for sellers

5. Results: Convergence to Equilibrium
The double oral auctions tend to converge rapidly towards equilibrium and achieve high levels of efficiency.
Also holds when either demand or supply shifts over time.
Competitive market equilibrium, a central concept which is not generally observed in the field) can work (but not necessarily, and needs time to adjust

6. Competitive Equilibrium: Convergence Path and Division of Surplus (Source: Vernon Smith 1962)
When equilibrium division of surplus is unequal
Convergence from the direction of greater surplus
From above in the top panel
From below in the bottom panel
Convergence slow and far from perfect
Empirical properties affected by design of market institutions

7. Dissemination of information in asset markets
As with properties of competitive equilibria (and their dependence on market institutions), it was difficult to examine the information processing properties of asset markets from field data because we know little about information in possession of traders, and equilibrium prices under alternative theories of information dissemination
Experimental methods have allowed us to gain additional insight into these properties
A few examples

8. Table 1. Information Dissemination Equilibria in a
Simple Asset Market (Source: Plott and Sunder 1982)
State X
Prob. = 0.4
State Y
Prob. = 0.6
Trader Type
Expected
Dividend I
400
100
220 II
300
150
210
III
125
175
155
PI Eq. Price
Asset Holder
I Informed
I Uninformed
RE Eq. Price

9. Figure 4: Dissemination of Insider Information in Rational Expectations Equilibrium (Source: Plott and Sunder JPE 1982)

10. Investment Horizon and Price Indeterminacy
Asset markets with investors having term horizons matching the maturity of the security
Asset markets with investors having short term horizons: horizon ends before the security matures

11. Figure 4: Stock Prices and Efficiency of Allocations for Session 4
(Exogenous Terminal Payoff Session)
Source: Hirota and Sunder JEDC 2006)

12. Figure 11: Stock Prices and Efficiency of Allocations for Session 9
(Endogenous Terminal Payoff Session)
Source: Hirota and Sunder JEDC 2006

13. Equilibrium selection
When two or more equilibria are mathematically plausible, human experiments can help choose among them
For example, in overlapping generations models of money, there are typically an infinity of equilibria, including one competitive and a range of strategic (for small number of agents) stationary equilibria—all mathematically plausible
Do economies populated with human agents choose stationary or non-stationary equilibria?

14. Source: Marimon and Sunder Econometrica 1993

15. Source: Marimon and Sunder Econometrica 1993

16. Public goods Free rider problem and under-production of public goods
Voluntary anonymous contribution literature
We examine public good financing in a general equilibrium economy by taxation
Rate set exogenously
Rate set by vote (median proposal)
Choose between voluntary contribution and taxation by vote (and choose tax rate)

17. T1: Tax rate fixed, starting level of public good at optimum

18. Optimization in economics

19. Optimization in Economics
Adam Smith: It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages. (I.2.17)
7/15/2019
Decoupling Markets

20. Background Competitive equilibrium Jevons Pareto efficiency Convexity
Maximization
Uniqueness (?) in presence of wealth effects
7/15/2019
Decoupling Markets

21. Background Herbert A. Simon (with Newell, 1959)
Limited human cognition
Bounded rationality and satisficing instead of maximization
Means-end heuristic as a descriptive model of human behavior (~ first order adaptive process) in General Problem Solver (GPS)
Selten
7/15/2019
Decoupling Markets

22. Background Gary S. Becker (JPE 1962)
Distinguish rationality at market and individual levels
Negatively-sloped demand curves result from the change in opportunities sets alone, largely independent of the decision rule; derivable from maximizing as well as random behavior
7/15/2019
Decoupling Markets

23. Background Vernon L. Smith (JPE 1962) In a double auction
Profit motivated human traders
Only traders
Observed market outcomes close to competitive equilibrium (derived from maximization and atomistic competition)
7/15/2019
Decoupling Markets

24. Background Gode and Sunder (JPE 1993): Combine
Double auction market institution (without randomization in Smith), and
Budget constrained random choice (without market institution in Becker)
With zero-intelligence (ZI) traders, market outcomes approximate predictions of competitive equilibrium
Allocative efficiency of markets populated by “zero-intelligence” traders is high, and comparable to efficiency of markets populated with profit-motivated human traders
7/15/2019
Decoupling Markets

25. 7/15/2019
Decoupling Markets

26. 7/15/2019
Decoupling Markets

27. 7/15/2019
Decoupling Markets

28. 7/15/2019
Decoupling Markets

29. 7/15/2019
Decoupling Markets

30. 7/15/2019
Decoupling Markets

31. 7/15/2019
Decoupling Markets

32. 7/15/2019
Decoupling Markets

33. 7/15/2019
Decoupling Markets

34. 7/15/2019
Decoupling Markets

35. 7/15/2019
Decoupling Markets

36. 7/15/2019
Decoupling Markets

37. 7/15/2019
Decoupling Markets

38. Theoretical Derivation vs. Actual Attainment of Equilibria
Equilibrium results mostly derived by assuming optimization by agents populating the model economies
At least since Simon, cognitive limitations of intuitive human behavior have been well-documented, raising doubts about the descriptive validity of such derived results
Given rise to a critique of rationality assumption as outdated psychology, lightning-fast calculation, perfect anticipation, perfectly ordered preferences, hedonistic motivation, and other presumably unrealistic individual behavior
Defense of economic theory from cognitive sciences critique of rationality assumption has often relied on:
Rationality as a broad tendency, need not apply to all
Selection and survival of the fittest (Alchian)
Proof of the pudding in the eating (empirical evidence)
Some important results (e.g., downward sloping demand functions) are robust, derivable not only from rational but also from non-rational behavior
7/15/2019
Decoupling Markets

39. Equilibria as Basins of Attraction
Powerful results of economic theory have been derived from “a very approximate, simplified, abstracted characterization of the system at the level next beneath.”
Simon and Selten’s bounded rationality of individual behavior, and Smith and Plott’s markets may not be mutually inconsistent after all, even under uncertainty, information asymmetry, and heterogeneous preferences
The “economic man” is maligned by a misunderstanding of its scientific purpose and role
Economics borrowed optimization from physics as a structural principle to identify basins of attraction (not as a behavioral description)
Adam Smith may not have gone far enough; a large part of economic efficiency is generated by common-sense constraints on economic choices, not because people are smart
Perhaps we have evolved social institutions such as markets to compensate for our cognitive limitations
7/15/2019
Decoupling Markets

40. Seven Challenges Ahead
Half a century after its introduction, experimental method in economics has to take responsibilities of “adulthood”
Addressing core concerns of economic discipline (in addition to methodology): What is the question?
Constructive mutual interchange with sister methodologies of the discipline: Why an experiment?
Sources of research questions
Time
Institutions
Simplicity: What is essential? And Not?
Robustness check
7/15/2019
Design of Experiments

41. Shyam.sunder@yale.edu www.som.yale.edu\faculty\sunder\research
Thank You.