An Introduction to Market Experiments

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An Introduction to Market Experiments

• Catherine Eckel
• University of Texas at Dallas

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Introduction

• Market experiments laboratory for policy
  testing and development
• Hard to visualize what experiments are like
  without seeing one
• This auction is an example of one of the earliest
  and most powerful experiments

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Overview of Experiment

• Each table is a trading team in the experiment -
  buyer or seller
• Make decisions about your trading strategy as a
  group between rounds
• Designate one person as the trader to act for
  your group during the trading periods

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Sellers

• Each seller receives a cost of production
• Your cost is the number on your record sheet
• Costs are reallocated each round
• Sellers make money by selling above their cost
• Remember Your objective is to earn as much
  profit as you can
• If your unit sells, you earn price cost.
  Otherwise you earn 0.
• If you do not sell you do not incur production
  cost

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Buyers

• Each buyer has a reservation value
• Your value is the number on your record sheet
• Values are reallocated each round
• Buyers make money by buying below their value
• Remember Your objective is to earn as much
  profit as you can
• If you buy a unit, you earn Your Value Price.
  Otherwise you earn 0.
• You do not make a profit on unbought units

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The Market

• All buyers and sellers receive values, costs
• At any time, a buyer can raise his bidding card
  and when recognized say Buyer X bids ___
• At any time, a seller can raise her bidding card
  and when recognized say, Seller Y offers ___
• Bids and offers are recorded by the recorder
• Bids have to improve on previous bids, and offers
  have to be lower than the previous offer.

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The Market, contd.

• At any time, any buyer can accept the outstanding
  offer (raise your card!)
• At any time, any seller can accept the
  outstanding bid (raise your card!)
• When a buyer and seller agree a sale is made.
  Write down on your record sheet your price and
  profit.
• Then all bids and offers are automatically
  withdrawn.
• The market ends when there are no more trades, or
  4 minutes, whichever comes first.

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Your record sheet Sellers
Record whether your unit sold, the price you
sold it for, and your profit (price - cost). In
the bottom of the form record information for the
round, including any comments
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Your record sheet Buyers
Record whether you bought a unit, the price you
bought it for, and your profit (value -
price). In the bottom of the form record
information for the round, including any comments
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Fill out your record sheet

• Use one box for each round
• Notice your cost or value (it will change each
  round)
• When your unit sells, fill out price
• Record whether your unit sold and calculate
  profit
• Record market information
• High and low price
• Units sold
• Comments space lets you record particular things
  about this round.

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How the experiment will go

• The floor will open
• Bids must go up, offers must come down
• When a bid and offer agree (or a bid or offer are
  accepted) a trade is made
• All outstanding bids and offers are withdrawn,
  and the floor reopened.
• If you traded your unit, you are done for this
  round
• If you did not trade your unit, you may still
  trade
• When there are no more trades the market closes
• We will do several rounds of the market
• Costs and values are reshuffled each round to
  give everyone a chance to earn money.

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Remember

• Buy low and Sell high
• Try to make as much money as you can
• Envelope contains the prediction

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What did we do?

• Reproduced a market in the lab!
• Sellers had induced costs
• Buyers had induced values
• Implemented a specific trading institution
• Oral Double Auction
• When we collect data people are paid what they
  earn.

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What Else Can You Do With this Market?

• Examine the effects of policy changes
• Taxes
• Quotas
• Tariffs
• Price Ceilings and Floors
• Examine the results of changes in supply and/or
  demand by changing seller costs and buyer values

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Results of a Double Auction Market Experiment
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What else can you do?

• Compare trading institutions
• Differences in the rules for trading
• Example What is the effect of rules that
  prohibit insider trading?
• Design new markets
• Economic engineering wind tunnel design
• Example
• Markets for pollution permits
• Smart market for wholesale electricity

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Take home message

• Markets can be reproduced in the lab
• Double auction lab markets converge quickly to
  competitive equilibrium
• Lab markets can be used to test theories or
  examine policies
• Lab markets can be used for wind tunnel design
  of new markets