Graduate Experimental Economics

1
Graduate Experimental Economics

• Lecture 7
• John Hey

2
Markets and Trading Institutions

• There are lots of market mechanisms.
• Posted bid.
• Posted ask.
• Pairwise bargaining.
• Clearing house.
• Double auction.
• We shall focus on the latter.

3
Setting up a Market Experiment

• Inducing demand.
• Inducing supply.
• Defining the market trading mechanism the
  market institution.
• Implementing the trading mechanism in the
  laboratory.

4
Inducing Demand

• We shall start with the single unit case.
• Each buyer wants to buy at most one unit of the
  good.
• The experimenter gives to each potential buyer a
  reservation price r.
• If the subject buys at a price p then the
  experimenter pays the subject r-p.
• This is the buyers profit or surplus.

5
Inducing Supply

• We shall start with the single unit case.
• Each seller wants to sell at most one unit of the
  good.
• The experimenter gives to each potential seller a
  reservation price r.
• If the subject sells at a price p then the
  experimenter pays the subject p-r.
• This is the sellers profit or surplus.

6
An Example

• Suppose that there are five potential buyers with
  reservation prices 10, 9, 8, 8 and 8.
• Suppose that there are four potential sellers
  with reservation prices 4, 5, 6 and 8.
• The implied supply and demand curves are shown on
  the next slide.

7
(No Transcript)
8
The Equilibrium

• The competive equilibrium is clearly defined (at
  a price of 8 and with a quantity of either 3 or
  4).
• Note who buys and the surpluses in the
  competitive equilibrium.
• Note also that theory says only that the
  equilibrium exists and not that it will be
  attained or how.
• That is the reason to do experiments.

9
Double Auction Mechanism

• Any buyer can at any time post a bid which is a
  price at which is willing to buy.
• Any seller can at any time post a ask which is
  a price at which is willing to sell.
• Bids and asks are displayed for all to see.
• Buyers can accept any ask.
• Sellers can accept any bid.
• Surpluses are calculated at traded prices.

10
Early Experiments

• The work of Vernon Smith was early and
  influential.
• Smith V, "An Experimental Study of Competitive
  Market Behavior", Journal of Political Economy,
  70, 111-137, 1962.
• We will look at some of his results and in the
  seminar we will experience a market experiment.

11
(No Transcript)
12
Surpluses and Efficiency

• We note that an important property of the
  competitive equilibrium is that the total surplus
  is maximised.
• In an experimental context it means that the
  subjects collectively take as much money off the
  experimenter as possible.
• Of course, this says nothing about the
  distributions of the profits/surpluses and
  whether it is any way just or fair.

13
Other Results

• Vernon Smiths paper amply repays reading.
• He examines many different demand and supply
  schedules...
• ...and also cases in which either the demand and
  supply curves shift at some point in the trading
  process.
• Convergence to market equilibrium is amazing.
• Four more examples, the first two with fixed
  demand and supply, the last two with shifts in
  the curves.

14
(No Transcript)
15
(No Transcript)
16
(No Transcript)
17
(No Transcript)
18
Why?

• Is this evidence of Adam Smiths Invisible Hand?
• Interesting evidence also from ZITs.
• A ZIT is a Zero Intelligence Trader...
• ...bids or asks half (part) way between
  reservation price and prevailing price.
• Also fast convergence.
• Are humans like ZITS ...or vice versa?

19
Charlie Holts Double Auction

• The Instructor goes to
• http//veconlab.econ.virginia.edu/admin.htm
• The students go to http//veconlab.econ.virginia.e
  du/login.htm
• We will run a Double Auction experiment.
• It is slightly different from that which I have
  described in that one accepts an ask (bid) by
  making a bid (ask) at the same price.

20
Conclusions

• Other market institutions have also been
  studied...
• ...they also converge but often slower and
  possibly with some bias.
• We are still waiting for a theorist to explain
  what is going on!

21
Clearing House Mechanism

• Each buyer puts in a (p,q) bid and each seller a
  (p,q) ask. Then the computer draws the implied
  demand and supply schedule and finds the
  equilibrium.

Buyer 1 (4? 4) Buyer 2 (3? 3) Buyer 3 (2?
2) Seller 1 (1? 1) Seller 2 (2? 2) Seller
3 (3? 3)
22
(No Transcript)
23
E

• h