Experimental economics is the application of experimental methods to study economic questions. Experiments are used to test the validity of economic theories and test-bed new market mechanisms. Using cash-motivated subjects, economic experiments create real-world incentives to help us better understand why markets and other exchange systems work the way they do. Experiments may be conducted in laboratory settings or in the field. Also see Simulations and games in economics education.
Experimental topics
Economics experiments can be loosely classified into the following topics: Markets,
GameA game is a structured activity, usually undertaken for enjoyment and sometimes used as an educational tool. Games are distinct from work, which is usually carried out for remuneration, and from art, which is more concerned with the expression of ideas...
s,
Decision makingDecision making can be regarded as an outcome of mental processes leading to the selection of a course of action among several alternatives. Every decision making process produces a final choice...
,
BargainingBargaining or haggling is a type of negotiation in which the buyer and seller of a good or service dispute the price which will be paid and the exact nature of the transaction that will take place, and eventually come to an agreement. Bargaining is an alternative pricing strategy to fixed prices...
, Auctions, Coordination, Social Preferences, Learning,
MatchingIn the mathematical discipline of graph theory, a matching or edge-independent set in a graph is a set of edges without common vertices. It may also be an entire graph consisting of edges without common vertices.- Definition :...
, and Field Experiments.
Coordination games
Coordination games are games with multiple pure strategy nash equilibria. There are two general sets of questions that experimental economists typically ask when examining such games: (1) Can laboratory subjects coordinate, or learn to coordinate, on one of multiple equilibria, and if so are there general principles that can help predict which equilibrium is likely to be chosen? (2) Can laboratory subjects coordinate, or learn to coordinate, on the Pareto best equilibrium and if not, are there conditions or mechanisms which would help subjects coordinate on the Pareto best equilibrium? Deductive selection principles are those that allow predictions based on the properties of the game alone. Inductive selection principles are those that allow predictions based on characterizations of dynamics.
Learning Experiments
In games of two players or more, the subjects often form beliefs about what actions the other subjects are taking and these beliefs are updated over time. This is known as belief learning. Subjects also tend to make the same decisions that have rewarded them with high payoffs in the past. This is known as reinforcement learning.
Until the 1990s, simple adaptive models, such as Cournot best response or
fictitious playIn game theory, fictitious play is a learning rule first introduced by G.W. Brown . In it, each player presumes that her/his opponents are playing stationary strategies. At each round, each player thus best responds to the empirical frequency of play of his opponent...
, were generally used. In the mid-1990s,
Alvin E. RothAlvin E. "Al" Roth is an American economist currently serving as the George Gund Professor of Economics and Business Administration at Harvard Business School...
and Ido Erev demonstrated that reinforcement learning can make useful predictions in experimental games. In 1999,
Colin CamererColin F. Camerer is an American behavioral economist and a professor at the California Institute of Technology ....
and Teck Ho introduced Experience Weighted Attraction (EWA), a general model that incorporated reinforcement and belief learning, and shows that fictitious play is mathematically equivalent to generalized reinforcement, provided weights are placed on past history.
Criticisms of EWA include overfitting due to many parameters, lack of generality over games, and the possibility that the interpretation of EWA parameters may be difficult. Overfitting is addressed by estimating parameters on some of the experimental periods or experimental subjects and forecasting behavior in the remaining sample (if models are overfitting, these out-of-sample validation forecasts will be much less accurate than in-sample fits, which they generally are not). Generality in games is addressed by replacing fixed parameters with "self-tuning" functions of experience, allowing pseudo-parameters to change over the course of a game and to also vary systematically across games.
Modern experimental economists have done much notable work recently. Roberto Weber has raised issues of learning without feedback. David Cooper and John Kagel have investigated types of learning over similar strategies. Ido Erev and Greg Barron have looked at learning in cognitive strategies. Dale Stahl has characterized learning over decision making rules.
Charles A. HoltCharles A. Holt is a behavioral economist, the A. Willis Robertson Professor of Political Economy at the University of Virginia.Among others he has written the textbook Markets, Games & Strategic Behavior ISBN 0-321-41931-6....
has studied logit learning in different kinds of games, including games with multiple equilibria. Wilfred Amaldoss has looked at interesting applications of EWA in marketing. Amnon Rapoport,
Jim ParcoJames Edward "Jim" Parco is a United States Air Force lieutenant colonel and a Professor of Leadership and Strategy at the Air Command and Staff College in Montgomery, Alabama.-Background:Parco was born in Pueblo, Colorado....
and Ryan Murphy have investigated reinforcement-based adaptive learning models in one of the most celebrated paradoxes in game theory known as the
centipede gameIn game theory, the centipede game, first introduced by Rosenthal , is an extensive form game in which two players take turns choosing either to take a slightly larger share of a slowly increasing pot, or to pass the pot to the other player...
.
Market games
Vernon SmithVernon Lomax Smith is professor of economics at Chapman University's Argyros School of Business and Economics and School of Law in Orange, California, a research scholar at George Mason University Interdisciplinary Center for Economic Science, and a Fellow of the Mercatus Center, all in Arlington,...
conducted pioneering economics experiments on the convergence of prices and quantities to their theoretical competitive equilibrium values in experimental markets. Smith studied the behavior of "buyers" and "sellers", who are told how much they "value" a fictitious commodity, and then are asked to competitively "bid" or "ask" on these commodities following the rules of various real world market institutions, such as the
Double auctionA double auction is a process of buying and selling goods when potential buyers submit their bids and potential sellers simultaneously submit their ask prices to an auctioneer, and then an auctioneer chooses some price p that clears the market: all the sellers who asked less than p sell and all...
(both sides can bid) used in many stock exchanges, as well the English auction and the Dutch auction (see
AuctionAn auction is a process of buying and selling goods or services by offering them up for bid, taking bids, and then selling the item to the highest bidder...
s). Smith found that in some forms of centralized trading, prices and quantities traded in such markets converge on the values that would be predicted by the economic theory of
perfect competitionIn neoclassical economics and microeconomics, perfect competition describes the perfect being a market in which there are many small firms, all producing homogeneous goods...
, despite the conditions not meeting many of the assumptions of perfect competition (large numbers, perfect information).
Over the years, Smith pioneered -along with other collaborators- the use of controlled laboratory experiments in economics, and established it as a legitimate tool in economics and other related fields.
Charles PlottCharles Raymond Plott, born in 1938, is an American economist. He currently is Edward S. Harkness Professor of Economics and Political Science at the California Institute of Technology and a pioneer in the field of experimental economics....
of the
California Institute of TechnologyThe California Institute of Technology is a private research university located in Pasadena, California, United States. The Institute maintains a strong emphasis on the natural sciences and engineering, and operates and manages NASA's neighboring Jet Propulsion Laboratory...
collaborated with Smith in the 1970s and pioneered experiments in political science, as well as using experiments to inform economic design or engineering to inform policies. In 2002, Smith was awarded (jointly with
Daniel KahnemanDaniel Kahneman is an Israeli psychologist and Nobel laureate, notable for his work on the psychology of judgment and decision-making, behavioral economics and hedonic psychology....
) the Bank of Sweden Prize in Economic Sciences "for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms".
Finance
Experimental financeThe goals of experimental finance are to establish different market settings and environments to observe experimentally and analyze agents' behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanism and returns processes...
studies financial markets with the goals of establishing different market settings and environments to observe experimentally and analyze agents' behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanism and returns processes. Presently, researchers use simulation software to conduct their research.
For instance, experiments have manipulated
information asymmetryIn economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry. Examples of this problem...
about the
holding valueHolding value is an indicator of a theoretical value of the asset that someone has in his portfolio. It is a value which sums the impacts of all the dividends that would be given to players in the future, to help them to estimate a price to buy or sell assets...
of a bond or a share on the pricing for those who don't have enough information, in order to study
stock market bubbleA stock market bubble is a type of economic bubble taking place in stock markets when market participants drive stock prices above their value in relation to some system of stock valuation....
s.
Social preferences
The term "social preferences" refers to the concern (or lack thereof) that people have for each other's well-being, and it encompasses altruism, spitefulness, tastes for equality, and tastes for reciprocity. Experiments on social preferences generally study economic games including the
dictator gameThe dictator game is a very simple game in experimental economics, similar to the ultimatum game. Experimental results in the dictator game have often been cited as a conclusive rebuttal of the rationally self-interested individual model of economic behavior, although precisely what to conclude...
, the
ultimatum gameThe ultimatum game is a game often played in economic experiments in which two players interact to decide how to divide a sum of money that is given to them. The first player proposes how to divide the sum between the two players, and the second player can either accept or reject this proposal. ...
, the trust game, the
public goods gameThe Public goods game is a standard of experimental economics; in the basic game subjects secretly choose how many of their private tokens to put into the public pot...
, and modifications to these canonical settings.
As one example of results,
ultimatum gameThe ultimatum game is a game often played in economic experiments in which two players interact to decide how to divide a sum of money that is given to them. The first player proposes how to divide the sum between the two players, and the second player can either accept or reject this proposal. ...
experiments have shown that people are generally willing to sacrifice monetary rewards when offered low allocations, thus behaving inconsistently with simple models of self-interest. Economic experiments have measured how this deviation varies across cultures. (More market-oriented societies tend to have higher
inequity aversionInequity aversion is the preference for fairness and resistance to incidental inequalities. The social sciences that study inequity aversion sociology, economics, psychology, and anthropology.- Human studies :...
.)
Guidelines
Experimental economists generally adhere to the following methodological guidelines:
- Incentivize subjects with real monetary payoffs.
- Publish full experimental instructions.
- Do not use deception.
- Avoid introducing specific, concrete context.
Critiques
The above guidelines have developed in large part to address two central critiques. Specifically, economics experiments are often challenged because of concerns about their "internal validity" and "external validity", for example, that they are not applicable models for many types of economic behavior, so the experiments simply aren't good enough to produce useful answers.
See also
- Behavioural economics, Behavioral finance
Behavioral economics and behavioral finance are closely related fields that have evolved to be a separate branch of economic and financial analysis which applies scientific research on human and social, cognitive and emotional factors to better understand economic decisions by consumers, borrowers,...
, Behavioral Operations ResearchBehavioral Operations Research examines the behavior of actual human agents in complex decision problems. BOR is the operations management analog of experimental economics and behavioral finance, and is part of the field known as management science....
- Experimental finance
The goals of experimental finance are to establish different market settings and environments to observe experimentally and analyze agents' behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanism and returns processes...
- Experimental techniques
Experimental research designs are used for the controlled testing of causal processes. The general procedure is one or more independent variables are manipulated to determine their effect on a dependent variable...
- Important publications in experimental economics
- Quantitative behavioral finance
Quantitative behavioral finance is a new discipline that uses mathematical and statistical methodology to understand behavioral biases in conjunction with valuation...
- Reinhard Selten
Reinhard Selten is a German economist.Selten was born in Breslau in Lower Silesia, now in Poland, to a Jewish father and Protestant mother. For his work in game theory, Selten won the 1994 Nobel Memorial Prize in Economic Sciences...
is another central figure in the foundation of experimental economics.
Experimental economics organizations
- Economic Science Association, the international association of experimental economists.
- Computable and Experimental Economics Laboratory at University of Trento, Italy (CEEL)
- Economics Research Laboratory at Texas A&M University (ERL-TAMU)
- CentERlab, Tilburg University, the Netherlands
- Experimental Economics Laboratory at University of Maryland (EEL-UMD)
- ICES, Interdisciplinary Center for Economic Science at George Mason University
- (ESI) Economic Science Institute at Chapman University
- Madrid Laboratory for Experimental Economics (MadLEE), at Universidad Autónoma de Madrid
- xs/fs, Experimental Social Science at Florida State University
- Magdeburg Laboratory for Experimental Economics
- Erfurt Laboratory for Experimental Economics
- Bonn Experimental Economics Laboratory
- UC Berkeley Experimental Economics - Xlab
- Center for Research in Experimental Economics and political Decision-making (CREED) at Universiteit van Amsterdam
- Laboratory for Experimental Economics and Political Science (EEPS) at California Institute of Technology
- Center for Experimental Social Science (CESS) at NYU
- Social Science Experimental Laboratory (SSEL) at Caltech
- California Social Science Experimental Laboratory (CASSEL) at UCLA
- Pittsburgh Experimental Economics Lab (PEEL) at University of Pittsburgh
- University of Arizona Economic Science Laboratory
- Learning and Experimental Economics Projects (LEEPS) at UCSC
- Interdisciplinary Center for Economic Science (ICES)
- Centre for Decision Research and Experimental Economics (CeDEx)
- Laboratoire Montpelliérain d'Economie Expérimentale (LEEM) LEEM's Laboratory (France)
- Finance and Economics Experimental Laboratory at Exeter (FEELE), Exeter University, UK
- Laboratory of Social and Economic Experiments, Poland
- French LABoratory of EXperimental Economics (LABEX)
- Bell University Laboratory in Electronic Commerce and Experimental Economics at CIRANO
- Bilgi Economics Lab of Istanbul (BELIS) at Istanbul Bilgi University
- Laboratory for experimental and behavioural economics at State University - Higher School of Economics
The State University - Higher School of Economics , colloquially known as Vyshka , is a Russian University specializing in social sciences. It was founded in 1992 as an MA training centre but soon offered Bachelor programmes in economics...
, Russia
Software
Education