Trading in the Pit Market

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Trading in the Pit Market

• Dr. Nikos Nikiforakis
• The University of Melbourne

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Overview

• Purpose of this talk
• Use experiments and experimental results as a
  vehicle for discussion
• Explain what we mean by markets
• Derive and explain theoretical predictions of
  market outcomes and desirability of competitive
  markets
• Discuss (briefly) the importance of trading
  institutions
• Ultimately, goal is to show the complementary
  role of economic theory and experiments

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What is a market?

• A place or institution in which buyers and
  sellers of a good or asset meet. (Oxford
  Dictionary of Economics)
• Markets facilitate trade
• Bring buyers and sellers together
• Aggregation of information
• Help traders strike agreements

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Theoretical framework

• Optimization principle people try to achieve
  the best deal they can.
• Units are homogeneous.
• Equilibrium the price(s) where neither buyers
  nor sellers have an incentive to change their
  behaviour.

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Demand side (buyers)
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Demand side (buyers)
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Supply side (sellers)
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Supply side (sellers)
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Market
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Market
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Market
Consumer surplus
Producer surplus
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Market predictions

• Let p be the price where supply and demand
  curves cross.
• If pgtp gt excess supply will tend to lower
  prices.
• If pltp gt excess demand will tend to raise
  prices.
• If pp there is no force to change the price.
• The market price (p) determines the quantity to
  be traded (q)

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About experiment (1)

• Variant of first recorded experiment in economics
  (Chamberlin, 1948)
• Chamberlin found that market predictions dont
  work!
• I predict that the same will apply in our case
  (reasons will be explained).

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Behaviour in experiment (1)
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Behaviour in experiment (1)
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About experiment (2)

• Variant of experiment by Smith (1962) Nobel
  laureate 2002.
• Smith argued that Chamberlins experiment was too
  decentralized unlike real markets.
• Experiment (1) was even more decentralized. In
  fact it was hardly a market.

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About experiment (2)

• Smith (1962) found that the predictions work
  remarkably well in a centralized trading
  institution (double-auction).
• Experiment (2) was less centralized than Smiths,
  but it should still have worked alright. Lets
  see

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About experiment (2)
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About experiment (2)
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About experiment (2)
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Behaviour in experiment (2)
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Behaviour in experiment (2)
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Summary of what we learned

• Economic theory can help us predict market
  outcomes.
• Creation of markets can lead to gains from trade,
  lower prices, increases in efficiency.
• Competitive markets maximise efficiency.
• Competitive markets work under very
  disadvantageous conditions
• Few buyers and sellers (theory assumes that many
  more would be required)
• Minimal informational requirements (i.e. each
  person only needs knows his/her value/cost)

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Question 1

• Would our results change if instead of both
  buyers and sellers shouting prices we had only
  sellers announcing prices?
• Would theoretical predictions change?
• Would behavior change?

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Question 2

• Why do you think we decided to pay you for your
  performance in only one of the experiments?

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Question 3

• The optimization principle assumes that you will
  try to strike the best deal possible. That is,
  you would prefer a deal with a profit of 1 to no
  deal.
• Would you accept this deal if you knew the other
  person was making a profit of 10?
• How would this change the results?

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Further reading

• Microeconomics
• Varian, Hal. (1999) Intermediate Microeconomics
  A Modern Approach, Norton Co, New York.
• Experimental Economics Institutions
• Kagel, J. and Roth, A. (1995) The Handbook of
  Experimental Economics, Princeton Univ. Press,
  New Jersey.
• Davis, D. and Holt, C. (1993) Experimental
  Economics, Princeton Univ. Press, New Jersey.
• Holt, Charles (1995) Industrial Organization A
  Survey of Laboratory Research, in The Handbook of
  Experimental Economics, Princeton Univ. Press,
  New Jersey. (available on-line)