Ryan Oprea. Economics 176

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1 1. s and Ryan Oprea University of California, Santa Barbara

2 Induced Supply and Demand One of the most important tools in experimental economics is the ability to induce preferences.

3 Induced Supply and Demand One of the most important tools in experimental economics is the ability to induce preferences. In market experiments (like the double auction experiment) we often induce Reservation values (maximum amounts buyers are willing to pay) and Marginal costs (minimum amounts sellers are willing to accept)

4 Induced Supply and Demand One of the most important tools in experimental economics is the ability to induce preferences. In market experiments (like the double auction experiment) we often induce Reservation values (maximum amounts buyers are willing to pay) and Marginal costs (minimum amounts sellers are willing to accept) Doing this gives us 1 Demand curves (by ordering reservation values from highest to lowest) 2 Supply curves (by ordering marginal costs from lowest to highest)

5 Induced Supply and Demand

6 Competitive equilibrium theory Often our goal with an experiment is to test economic theory. By inducing supply and demand and allowing exchange we get an opportunity to test competitive equilibrium theory.

7 Competitive equilibrium theory Often our goal with an experiment is to test economic theory. By inducing supply and demand and allowing exchange we get an opportunity to test competitive equilibrium theory. Provides us with three predictions: 1 Prices will converge to where supply equals demand. 2 Quantities will converge to where supply equals demand. 3 Total surplus will reach the maximum possible rate.

8 Standard Double Auction Results

9 Beyond competitive equilibrium theory also allow us to ask questions that are hard to pose with theory.

10 Beyond competitive equilibrium theory also allow us to ask questions that are hard to pose with theory. In this case we can ask some questions that theory provides little guidance on: What kind of information to traders need to find competitive equilibrium? Economic theory claims everyone needs to know everything. But experiments show this is quite wrong why this is wrong is still an open question!

11 Beyond competitive equilibrium theory also allow us to ask questions that are hard to pose with theory. In this case we can ask some questions that theory provides little guidance on: What kind of information to traders need to find competitive equilibrium? Economic theory claims everyone needs to know everything. But experiments show this is quite wrong why this is wrong is still an open question! How many traders must there be to reach competitive equilibrium? Economic theory claims you need a huge number, but this isn t true in experiments. Don t need to be a price taker to trade to competitive equilibrium!

12 Beyond competitive equilibrium theory also allow us to ask questions that are hard to pose with theory. In this case we can ask some questions that theory provides little guidance on: What kind of information to traders need to find competitive equilibrium? Economic theory claims everyone needs to know everything. But experiments show this is quite wrong why this is wrong is still an open question! How many traders must there be to reach competitive equilibrium? Economic theory claims you need a huge number, but this isn t true in experiments. Don t need to be a price taker to trade to competitive equilibrium! What institutions manage to generate competitive equilibrium outcomes? Traditional competitive theory provides zero guidance on this question!

13 Effect of Experience

14 Effect of Experience

15 Does Equity Matter?

16 Does Equity Matter?

17 Does Equity Matter?

18 Does Equity Matter?

19 Responsive to change but...

20 Responsive to change but...

21 ...what if change is unpredictable?

22 ...what if change is unpredictable?

23 What if the seller is a monopolist in a double auction?

24 What if the seller is a monopolist in a double auction? Competitive outcomes emerge!

25 Posted Offer s Financial markets often use double auctions, but most markets in developed economies use the posted offer institution: Seller makes take it or leave it price offers to buyers. We can change the rules of the trading institution to posted offer instead of double auction. Do these amazing results extend to other market institutions? We can run all of these experiments with the PO instead of the DA to find out.

26 Efficiency of Posted Offer s

27 Efficiency of Posted Offer s

28 Posted Offer: Does Equity Matter?

29 Posted Offer: Does Equity Matter?

30 Posted Offer: Does Equity Matter?

31 Posted Offer: Does Equity Matter?

32 Posted Offer: Responsive to change?

33 Posted Offer: Responsive to change?

34 Posted Offer: Behavior in monopoly?

35 Posted Offer: Behavior in monopoly?

36 The Big Questions Three big types of questions asked in economics: How do human beings make decisions, resulting in conscious outcomes? How do groups of individuals make decisions that result in unconscious mass outcomes? How do we set the rulest of the game to make these outcomes better. Most economics experiments are aimed at asking and answering these questions.

37 Economic Theory

38 Economic Theory A Model of Humans: Homo Economicus Instrumentally rational (utility maximizer) Substantively rational (i.e. Bayesian) Distinctive set of preferences Expected utility maximizer (Broadly) self interested Stationary time preferences

39 Economic Theory A Model of Humans: Homo Economicus Instrumentally rational (utility maximizer) Substantively rational (i.e. Bayesian) Distinctive set of preferences Expected utility maximizer (Broadly) self interested Stationary time preferences A Theory of Behavior: Equilibrium Focused on states of rest: outcomes where homo economicus doesn t want (or can t) do anything different. State of rest Competitive equilibrium Nash equilibrium Not much on how you get to equilibrium.

40 Traditional Empirics

41 Problem: Causality Traditional Empirics Need exogenous change in x to infer that a change in x causes a change in y.

42 Problem: Causality Traditional Empirics Need exogenous change in x to infer that a change in x causes a change in y. Problem: Unobservables Can t directly observe preferences Can t directly observe beliefs Often can t directly observe costs, production functions etc.

43 Problem: Causality Traditional Empirics Need exogenous change in x to infer that a change in x causes a change in y. Problem: Unobservables Can t directly observe preferences Can t directly observe beliefs Often can t directly observe costs, production functions etc. Problem: Confounds Can t observe other incentives Can t fully account for general equilibrium effects Real world is messy and things get in the way!

44 What is Experimental Economics? Experimental Economics Test economic theories in small laboratory settings. Control information, incentives and observe behavior Ranges from simple psychological tests to simulated, video-game like markets. Three basic types of experiments: 1 Individual choice experiments Test assumptions about Homo Economicus 2 Strategic interaction experiments Test game theory 3 experiments Test classic notions of competitive equilibrium

45 Two Types of

46 Studying Dynamics and Learning Two Types of Economics is dominated by equilibrium In the lab we can ask new questions Do people get there? How do people get there? Which one do they get to (if there is more than one)? What helps them get there? The lab adds dynamics, learning, feedback and unintentional outcomes to economics.

47 Studying Dynamics and Learning Two Types of Economics is dominated by equilibrium In the lab we can ask new questions Do people get there? How do people get there? Which one do they get to (if there is more than one)? What helps them get there? The lab adds dynamics, learning, feedback and unintentional outcomes to economics. Measuring Preferences and Beliefs Subjects bring in beliefs and preferences with them to the lab. We can design experiments to extract them. Risk preferences Social preferences Discount rates

48 Why Run? Learn about real world institutions. When do financial markets generate bubbles? Design better real world institutions. Can the FCC use an auction to efficiently allocate spectrums to broadcasters? Can firms use markets to predict the future? Inform policies What effects will mergers have on competitiveness of markets. Explore theoretical questions that are hard to model. How do firms behave when utterly uncertain. Evaluate the behavioral assumptions underlying economic theory to make them more predictive. Are people really Bayesian.

49 Examples What information do people need to have in order to trade to a competitive equilibrium? When do mergers create unhealthy market power? Do people act as though they are concerned with inequality? When do people contribute to the common good? Do Nash equilibria really explain peoples behavior?