Outline

January 18, 2005 Experimental Economics 1

OutlineIntroduction: Objectives and Course Expectation

Double Oral Auction Experiment: Observations

Foundations of experimental economics: Vernon Smith’s 1982 paper

Economic versus Psychological Experiments

January 18, 2005 Experimental Economics 2

Two Questions?

Why are you here?

What do you expect from this course?

January 18, 2005 Experimental Economics 3

Course Objectives

Understand the most important papers in experimental economics

Learn how to judge papers in experimental economics

Learn how to run good economic experiments (hand-on experience) Run one in class using others’ design Design and run one from scratch in a group project

Learn how to write a paper in experimental economics

January 18, 2005 Experimental Economics 4

Course Information Course emphasis

Design of Market Institutions (Double Oral Auction Market, Posted Price Market, Asset Markets, Auctions)

Behavioral Game Theory (Dominance Solvable Games, Coordination Games, Public Good, Empirical Alternatives to Nash, Learning)

Neuroeconomics and Field Experiments Learn to test economic theories experimentally

Teaching methodology In-class experiments Lectures (90%) Two guest speakers (Colin Camerer and Andy Schotter) Group project (hand-on experience) and presentation

January 18, 2005 Experimental Economics 5

Instructors & Contact InformationProfessor Teck H Ho (Teck-Hua Ho)

A Singaporean, call me Teck (as in Hi Tech)Research: Experimental and behavioral economics,

quantitative marketing, and marketing and production interface

Email: hoteck@haas.berkeley.edu Professor Shachar Kariv

An Israeli, call him ShacharResearch: Microeconomic theory, experimental economics,

and behavioral economicsEmail: kariv@berkeley.edu

January 18, 2005 Experimental Economics 6

Course Expectation Class participation (10%)

Attendance, participation, and running of an experiment Five minor write-ups (20%)

2-page, double-space, Times New Roman 12-point Font Critically evaluate one of the required readings Due on the day before the class begins NO LATE WORK IS ACCEPTED

Two major write-ups (20%) 4-page, double-space, Times New Roman 12-point Font Suggest and justify a way to extend existing research (based on a required reading) Due on the day before the class begins NO LATE WORK IS ACCEPTED

Group Project (40%) Two-member team (your buddy) Provide project definition by February 24th

Apply experimental protocol by March 17th Submit report by May 5th NO LATE WORK IS ACCEPTED

January 18, 2005 Experimental Economics 7

OutlineIntroduction: Objectives and Course Expectation

Double Oral Auction Experiment: Observations

Foundations of experimental economics: Vernon Smith’s 1982 paper

Economic versus Psychological Experiments

January 18, 2005 Experimental Economics 8

ObservationsWhat is the goal of the experiment?

What are the dependent variables?

What are the independent variables?

What are the control variables?

January 18, 2005 Experimental Economics 9

Buyers’ Value and Sellers’ Costs

January 18, 2005 Experimental Economics 10

Supply and Demand Curves

January 18, 2005 Experimental Economics 11

OutlineIntroduction: Objectives and Course Expectation

Double Oral Auction Experiment: Observations

Foundations of experimental economics: Vernon Smith’s 1982 paper

Economic versus Psychological Experiments

January 18, 2005 Experimental Economics 12

Microeconomic System

• The environment (e)– A list of economic agents (e.g., Daniel, Grace, etc.) (1,..,N)– A list of commodities (e.g., an antique to be auctioned)– Each agent is characterized by her utility function (ui), technology

(knowledge) (Ti), and commodity endowment (i)

• The Institution (I)– Define the rules of private property under which agents may

communicate and exchange or transform commodities for the purpose of modifying initial endowments in accordance with private tastes and knowledge

January 18, 2005 Experimental Economics 13

The Components of the Institution

• A language M = (M1,…, MN) consisting of messages m = (m1, …, mN)

• A set H=(h1(m), …, hN(m)) of allocation rules for each i as a function of the messages sent by all agents

• A set C=H=(h1(m), …, h N(m)) of cost imputation rules. The rule states the payment to be made by each agent in monetary units as a function of the messages sent by all agents

• A set G=(g1(t0,t,T), …, gN(t0,t,T)) of adjustment process rules. (A starting rule, a transition rule, and a stopping rule) (e.g., English auction)

January 18, 2005 Experimental Economics 14

Agent i’s characteristics andproperty rights

• Agent I is characterized by:

ei = (ui, i, Ti)• Agent i’s property rights in communication

and in exchange are defined by

Ii = (Mi, hi(m), ci(m), gi(t0,t,T))

January 18, 2005 Experimental Economics 15

Microeconomic System

January 18, 2005 Experimental Economics 16

Agent Behavior

• Outcome Behavior is defined by a function which yields the allocation-determining message mi sent by agent I with characteristic ei, given the property rights of all agents defined by I

mi = mi(T) = i (ei | I)• Response Behavior (exchange of messages in M that

precedes the final allocation-determining messages) is defined generically by a function which gives i’s message response mi(t), at time t, to earlier messages m(t-1) by all agents.

mi(t) = f i (m(t-1) | ei , I)

January 18, 2005 Experimental Economics 17

System Performance

• Allocation Outcomesxi = hi(m) = hi(1 (e1 | I),…, N (eN | I))

x0i = ci(m) = ci(1 (e1 | I),…, N (eN | I))

• Criteria– Pareto Optimality (Efficiency)– Division of Surplus

January 18, 2005 Experimental Economics 18

Microeconomic System

January 18, 2005 Experimental Economics 19

The Bottom Line• Agents choose messages and institutions determine

allocation via rules that translate messages into allocations

• Dependent variables:– What message mi does agent i send? (Outcome and

Response)– System performance (X):

• Pareto optimality• Division of surplus

• Independent/treatment variables: Rules of institution (I)

• Control variables: Environment, in particular preferences (e) (typically unobservable in the field)

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An Example: English versus Dutch Auction

• The Environment– Agents– Endowment and Cost

• The Institution– Language– Allocation Rules – Adjustment Process

• Independent Variables• Dependent Variables

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Induced Value Theory (Smith, AER, 1976)

Given a costless choice between two alternatives, identical except thatthe first yields more of the reward medium (usually currency) than thesecond, the first will always be chosen (preferred) over the second, byan autonomous individual, i.e., utility is a monotone increasing functionof the monetary reward (non-satiation)

Three qualifications:

-There may be subjective costs (or values) associated with market decisions-Individuals may attach game value to experimental outcomes-Individuals may not be autonomous own-reward maximizers

January 18, 2005 Experimental Economics 22

Sufficient Conditions for a Microeconomic Experiment

• Non-satiation: Prefer more $$$ than less• Saliency: Rewards must be associated with the message

actions of subjects• Dominance: A condition sufficient to guarantee that we have

not lost control over preferences [e.g., the reward structure dominates any subjective costs (or values) associated with participation in the activities of an experiment]

• Self-interest Seeking: Subjects care only about their own-payoffs

• Parallelism: Propositions about the behavior of individuals and the performance of institutions that have been tested in laboratory microeconomic systems apply also to non-laboratory microeconomic systems where similar conditions hold

January 18, 2005 Experimental Economics 23

Purposes of Experimentation

?

January 18, 2005 Experimental Economics 24

Purposes of Experimentation

• “Weep out” bad theories

• Predict behaviors in the field

• Establish limits of theories (i.e., stress tests)

• Discover new empirical regularities

January 18, 2005 Experimental Economics 25

OutlineIntroduction: Objectives and Course Expectation

Double Oral Auction Experiment: Observations

Foundations of experimental economics: Vernon Smith’s 1982 paper

Economic versus Psychological Experiments

January 18, 2005 Experimental Economics 26

Economic vs. Psychological Experiments

?

January 18, 2005 Experimental Economics 27

Economic vs. Psychological Experiments

ECONOMIC EXPERIMENTS PSYCHOLOGICAL EXPERIMENTS

LANGUAGE MOSTLY QUANTITATIVE MOSTLY VERBAL

TASK ABSTRACT CONTEXT

INCENTIVES FOR SUBJECT MONETARY NONE

THEORY PREDICTION MOSTLY POINT MOSTLY DIRECTIONAL

MODEL ESTIMATION OFTEN, GENERAL RARELY, CUSTOMIZED