2 - LEC 4 - MARKET EXPERIMENTS Flashcards
• What is a market experiment?
• Experiment in which
– Some experimental participants assigned the roles of buyers and/or sellers
– There are ‘goods’ that can be traded (often ‘induced value tokens’)
• Markets (usually) set up so that:
– There are potential gains from trade
- Experimenter controls rules of trade
- Experimenter observes what happens
Whats a market experiments a conjunction of
– Environment
• Participants, endowments, preferences, etc.
– Institution
• Rules of trade, who can do what and when, etc.
– Behaviour
• How market participants trade
• Experiments often involve
– Creation/manipulation of the environment/institution – Aim: observing consequent behaviour
how does a classic market experiment work
• Subjects divided at random into: Buyers, Sellers
• Each buyer Bi told:
– Maximum price (vi) they can pay for unit of fictitious commodity (token)
• Each seller Sj told:
– Minimum price (cj) at which they can sell a unit of
commodity
• vi and cj: private information for individuals
• If trade takes place between i and j at price p: – ΠBi = vi – p
–ΠSj =p–cj
• Smith asked participant to try to maximise profit
– Note: mainly hypothetical payoffs in this early experiment
how do you interpret payoffs in the classic market experiment
• If you think of vi as Bi’s value for a unit (or maximum willingness to pay)
– Then (vi – p) is a measure of the consumer’s surplus from buying at price p
• If you think of cj as Sj’s cost of production
– Then (p – cj) is the producer’s surplus from selling a unit at price p
• In the aggregate:
– The values given to buyers define a demand function
– Thus, for any potential price, the values determine the maximum quantity that can be purchased
Should we expect equilibrium in this experimental market?
– Demand and supply determine the feasible set of trades
– What will arise as the actual pattern of trading is an open question
explain the classroom experiment for markets
how does smith 1962 show institutions matter and uses ‘double auction’
• Sequence of trading periods (e.g., 5-10mins)
• Experimenter opens/closes trading periods
• At any time during trading period, buyers and sellers are free to make verbal offers (hence: double auction)
– Offers must respect maximum values/minimum costs
• Improvement rule for new offers
– Higher bid/lower offer than current best
• Any buyer/seller can accept an existing offer to buy/sell (subject to cost/value constraints)
• Acceptances result in binding contracts – Buyer/seller drop out of market
• Trading period may be timed or continue until no further contracts are being made
• How realistic are the experimental markets implemented in Smith (1962)?
• Similarities with markets outside the lab
– Traders ignorant of the other’s values
– Learn about other’s values by observing other’s willingness to trade
– Small number of traders
• Features unlike markets outside the lab
– Supply and demand held constant over trading periods in experiment
Are the results of smith 1962 surprising?
• What is the effect of a change in the market organisation so that only sellers can make offers?
- Buyers cannot make offers (only accept/reject)
- Possibly closer to an ordinary retail market
• Hypothesis: prices above equilibrium, since sellers would like to maximise profit
describe the Ketcham, Smith & Williams (1984): ‘A comparison of posted-offer and double-auction pricing institutions’, . paper
on a whole, how can we summarise market experiments.
• Many studies with double auctions replicate Smith’s findings
• Markets do tend to converge to competitive equilibrium
– Even with very few traders
– Regardless of precise conditions of demand and supply
• Demand and supply conditions do affect – Path of convergence
– Speed of convergence
– Distribution of income and profit
- Changes in the institutional organisation of markets can disturb convergence to the equilibrium
- Market can lead to high efficiency even for simple heuristics
- Main hypothesis: Markets erode moral standards relative to individual decision making
- Why would market lead to moral decay?
- Diffusion of responsibility
– Markets involve more than one party implying that responsibility and feelings of guilt are shared - Market provide social information about prevailing norms
– Observing others’ trade and ignoring moral standards leads to further engagement in market
– Mere existence of market might provide information on the appropriateness of trading - Framing of the decision
– Markets provide a framing for the decision that focuses on materialistic aspects
– May divert from possible adverse consequences and moral implications
describe the mouse paradigm - Falk & Szech (2013): ‘Morals and markets’.
• Lab experiment
– Participants face trade-off between money and doing harm
to a third party
• Participants randomly assigned to one of three institutions:
– Individual treatment: third party harmed if the participant accepts money
– Bilateral market: third party harmed if a pair of participants concludes a trade
– Multilateral market: as previous treatment, but many buyers/seller
• Decision:
– Either receive no money and to save the life of a mouse, or – Earn money and to accept the killing of a mouse
• Overall these results show that markets can erode moral standards
