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Experimental economics Mylene Lagarde, LSHTM Johannesburg, Nov 2007 HEPNet Workshop.

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Presentation on theme: "Experimental economics Mylene Lagarde, LSHTM Johannesburg, Nov 2007 HEPNet Workshop."— Presentation transcript:

1 Experimental economics Mylene Lagarde, LSHTM Johannesburg, Nov 2007 HEPNet Workshop

2 Overview 1.Background and characteristics of experimental economics 2.Applications Classic use: testing theories Recent developments: social preferences 3.Designing an experiment An example Main features of an experiment Some classic games 4.Relevance for health systems research 5.Possibilities and limitations of experimental economics

3 1. Background and characteristics of experimental economics

4 Origins : the willingness to test economic assumptions Micro-economics relies heavily on a number of assumptions Preferences/mechanisms are hard to observe in natural environments Need to test and therefore potentially refute these assumptions in a scientific way? –Market classroom experiment : Chamberlain (1948) and his student V. Smith (1962)

5 The influence of game theory Game theory attempts to model strategic interactions –How do agents choose strategies which will maximize their return, given the strategies the other agents choose They use simplified structures for modeling strategic behavior –Games provide a formal modelling approach to social situations in which decision makers interact with other agents Application to many problems –Political science, economics, etc.

6 Other major influences Psychology –Psychologists have used experiments with participants to test some assumptions on fundamental behaviours: authority Behavioural economics –Informing economic theory with lessons from psychology –Challenges neo-classic assumptions of economics (rationality, self-interest, stability of preferences, risk aversion, etc.)

7 Principles of experimental economics To create an (economic) situation in a neutral environment (lab) which is: –real Real people… … participating for real monetary stakes …following real rules –simple –controlled Motivations Initial information Interaction processes –reproducible And observe behaviours and outcomes

8 A method of empirical investigation 1.Testing theories and establishing empirical regularities as a basis for new theories 2.Elicitation of preferences: attitude towards risk, fairness, altruism, trust, time preferences 3. Testing policies: wind tunnel experiments

9 A young and blossoming field

10 The 2002 Nobel Prize in Economic Sciences "for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms" "for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty" Vernon L. SmithDaniel Kahneman

11 2. Some applications Classic use: testing theories Recent development: Field experiments Revealing social preferences

12 Main areas of application Financial economics –Information diffusion and aggregation, price setting mechanisms, irrationality, bubble formation Industrial economics –Design of incentives and contracts (improving performance), auction designs (electricity markets, air slot allocation, etc.) Environmental economics –Regulations to use common resources (fishery), to design pollution permit markets, etc. (public goods, externalities) Agricultural economics –Real market experiments: food auction, Actual WTP for cereals, etc.

13 Main fields of research Individual choices –inter-temporal choices, risk aversion, social preferences, etc. Strategic Interactions (game theoretic hypotheses) –contracts, conflicts/coordination, public goods, etc. Industrial organization –Market efficiency –Market power issues (development of collusion, cooperation) –Market design

14 Testing theories Neoclassical theory works (relatively) well for markets where important assumptions hold (prop rights well defined, perfect information, low transactions costs) BUT not always…. EE are simple tools which allow to isolate/measure the reasons for a models failure Models and principles that survive the testing can be used to address field questions

15 Testing regulations/policies Financial markets –Testing how to regulate markets to prevent irrational behaviour, the formation of bubbles, etc. Auction design –Testing one predictions of models with real individuals in a controlled environment Environment economics –How to regulate the use of rare resources –Regulations and externalities (pollution permits, etc.)

16 The spectrum of experiments Historically, EE has been applied in lab experiments –Participants = graduate students Computerized game or paper-based Neutral frame –To test theories, policies Move lab games into the field: a new practice –Paper based –Participants are not students, but real people –Experiments are tailored to a field context/policy, and less neutral –Experiments are used as tools to measure some values

17 The importance of social preferences Social preferences –preferences= choices made by individuals, tradeoffs btw different collections of things they value (time, money, prestige, leisure, etc.) –social preferences= how people rank different allocations of material benefits to themselves and others Existence and importance of social preferences –Social preferences have an impact on the enforcement of social norms: abundant literature on the effects of fairness, inequality (absence of), trust on economic behaviour, etc. –Evidence of adverse effects of (monetary) incentives if social preferences not accounted for (voluntary work, intrinsic motivation)

18 Revealing social preferences Difficult to identify them, even more to measure them –How do you observe altruism ? Fairness ? Inequality aversion (relative to each other)? Risk aversion ? Why use experiments to measure them? –Surveys on trust, altruism may be biased –Experiments are likely to suffer less from response bias to reveal fundamental preferences because of monetary stakes –Experiments allow quantification What types of preferences can experiments measure? –Social preferences: norms of altruism, fairness, trust, trustworthiness, aversion for inequity. –Other preferences: risk aversion, time preferences.

19 Social preferences in 15 small scale societies (1) Henrich et al. (AER 2005, Science 2006) Setting: project led by anthropologists, in 15 remote societies on 4 continents

20 Objectives: to investigate how social preferences vary across cultural environments Methods –Measures of altruism, fairness and aversion for inequality –Measures of market integration and other aspects of socio-economic life in these societies Results –preferences are not exogenous (as assumed by neo-classic economics) but shaped by the economic and social interactions of everyday life –Substantial variation among populations of aversion for inequality which co-evolves with norms of fairness/altruism –the canonical model of the self-interested material payoff- maximizing actor is systematically violated Social preferences in 15 small scale societies (2)

21 Using EE to measure preferences (1) Karlan (AER 2005) Setting: Peru, clients of a micro-credit program Objectives: investigating the determinants of default payment and saving Methods –uses survey and experimental measures of social capital -trustworthiness and willingness to cooperate; –Observes borrowing behaviour over 1.5 year Findings –Significant negative correlation between (magnitude of) trustworthiness and (1) probability of default, (2) dropout of dropping out of the program and (3) volume of savings –Some individuals are just not trustworthy and will not repay their loans? –TG can be a valid measurement tool for trustworthiness, less obvious for trust which is too context specific

22 Using EE to measure preferences (2) Carpenter and Seki (2006) and Carpenter and Seki (2004) Setting: Japan, individuals involved in different degrees in fishing activities and are exposed to different degrees of competition Objectives: –to investigate the level of competition in a work environment can explain the propensity to cooperate –to investigate whether the individual propensity to cooperate affects productivity Methods –uses experimental measures of cooperation –Uses surveys to measure productivity and level of competition Findings –The higher the degree of competition the less cooperative individuals are –The more cooperative individuals are, the higher their productivity

23 A new but growing field Many other examples of games used to measure social preferences –To see whether they help explain actual behaviours –To use them as outcomes (e.g. impact of education program on altruism amongst children) Currently implemented in Mexico: games piggy- backing on a national survey –to provide new insights into the role of preference heterogeneity in explaining economic decisions and enable new tests of hypotheses that seek to explain family behaviour

24 3. Designing an experiment Lets play a game ! Main characteristics of the game Examples of other games

25 Basic rules Please try to follow all the rules: –Listen and read carefully the instructions –If you have questions, raise your hand and I will come and answer it privately –Do not talk with each other, even when the experimenters are calculating the payoffs between rounds 100 ECU = US$ 1

26 Example with 3 players Players 1, 2 and 3 are given 200 ECU each Their decisions: Player 1 invests 0 in A Player 2 invests 100 in A Player 3 invests 200 in A Return on investment from A = 300 x 1.5=450 Return for all three players= 450/3= 150 Endowments at the end of round 1: Player 1 has 200 +150 = 350 Player 2 has 200 -100 +150 = 250 Player 1 has 200 -200 +150 = 150 Total invested in A = 300

27 Steps 1.Write your ID number on your response sheet 2.Write the amount you want to invest in A 3.Detach the bottom section of your answer sheet, fold it and place it in the box 4.Wait until you know the value of individual payoffs 5.Calculate yourself the value of your endowment at the end of the round 6.Play the next round

28 Public good game: interpretation and results Interpretation: –Propensity to cooperate (vs. free-ride) in a group, reciprocal behaviours in groups –Use of different types of regulations (external, communication) in different contexts: team compensation, cooperative production/maintenance, use of common resources Results: –Prediction: each player will contribute nothing (individual welfare vs. collective welfare with public goods bringing externalities) –One-shot game: 50% contribution ; contributions diminish over time (final period: contribution=0) –What contributes to increase cooperation Communication Possibility of individual punishment Disclosure of free-riding

29 What would be different for real Smaller group Participants dont make their own calculations ! You would be playing for real money Several treatments could be tested

30 Game procedures (1) Abstract setting –Anonymous players, playing once, for money, without communication –Not lifelike, but baseline to observe effects of any variant (communication, non-anonymity, etc.) Participants: –college students recruited with minimal knowledge of the task (e.g. Study on decision making) –More real people that you may want to observe Organization: –Ensure anonymity: private box, random drawing –Ensure credibility: existence of recipients if not present, real incentives paid at the end; DONT LIE

31 Game procedures (2) Instructions to describe rules: –Plain abstract language (benchmark) –Use letters/neutral framing –Avoid some words sharing, helping, trust –Examples, quiz Design characteristics –Multiple rounds vs. One-shot games Depends on the game If equilibrium situation, then multiple rounds to allow learning (then rematching) –Treatments vs. individual measurements

32 Game procedures (3) Giving interactions to participants in multi- player games: –Direct feedback –Strategy method: players make choices conditional on every single response of other player Treatments –Several groups: 1 difference per group (rules, framing, etc.) –Allows to measure the effect –Not necessary if objective= measurement of preferences for all individuals

33 Components of an experiment Institution (rules of the game) –Feasible actions –Sequence of actions –Information given –Knowledge of participants Framing of instructions –Abstract framing : basic incentives only –Framing matching reality to get at social norms: Participation to maintenance of a water well Health worker, community, patient –Interesting to compare abstract vs. real framing

34 Experimental variables to define Procedural design –Instructions –Illustrative examples and tests of understanding –Criteria for answering subjects questions –Trial periods Experiment characteristics –Payment –Recruiting subject pool, number of subjects –Matching procedures when interaction Environment –Date and place –Computerized or paper-based –Irregularities which occurred

35 Analysis of experiments Most analyses do not require sophisticated methods Measures of social preferences –Creation of proxies based on individual choices Descriptive analysis at group level underlying –Outcome variables under each treatment –Influence of simple socio-economic variables

36 A few examples of other games

37 Dictator Game PLAYER 1PLAYER 2 X $$% of X = measure of altruism

38 DG - interpretation and results Interpretation –Measure of altruism; aversion for inequality (knowledge that the other is poor), etc. –Relates to charitable giving Results –Prediction: no sharing BUT on average individuals give 20% –Allocations increase with needy/deserving recipients and decrease with anonymity –Norms vary across settings/countries –Game sensitive to setting, etc.

39 Ultimatum Game PLAYER 1PLAYER 2 X $$% of X = measure of preference for equity/fairness AGREES: Deal is made REFUSES: Both get NOTHING

40 UG – interpretation and results Interpretation –Measures of social norms of sanction –Relates to pricing in a monopoly situation, or last minute settlement Results: –Prediction: proposer sends the smallest possible unit (always accepted by recipient because better than nothing) –On average proposers offer 30-50% –Offers below 20% are rejected half of the time –Norms vary across settings and are well accepted (offers will be readily made according to norms) –Effects of competition: Btw proposers increases offers Btw recipients diminishes threshold of acceptance –No effect of anonymity

41 Third Party Punishment Game PLAYER 1PLAYER 2 X $$% of X = altruism under social norms pressure = measure of preference for equity/fairness X $ PLAYER 3 WATCHES SANCTION - k $ - Y $

42 TPP – interpretation and results Interpretation –Behaviour of punisher: Reveals aversion for inequality (against a shared norm): people who dislike it will take costly actions to reduce inequality Results –Prediction: No allocation from dictator ; observer never punishes dictator –The less dictator allocates, the higher is the sanction

43 Trust game PLAYER 1PLAYER 2 X $$% of X 2 x (% of X) Part of 2 x (% of X) = measure of trust = measure of trustworthiness

44 Trust – interpretation and results Interpretation –Trust of investor and reciprocity of trustees (trustworthiness) –Exchange of services without possibility to bind the second movers Results –Prediction: (expected) repayment from trustee: 0 and Entrusted/invested amount: 0 –On average investors give 50%, while trustees repay slightly less than that –The bigger the investment, the bigger the repayment

45 Bribery game Private citizens Public servants Other members of society $B $$ - Y $ Expected cost of being punished/ caught $$$ - $$ Expected cost of being punished/ caught + cost of producing the service - $$

46 Results from bribery games Very few examples, different versions/level of complexity Barr and Serra: –Experiments on students coming from different countries –positive correlation between internalized norms (Transparency international index) and corruption in the game –Contradicts 1 other experiment

47 4. Possible applications to health system issues Investigating corruption Revealing the influence of social preferences Health insurance Designing incentives, contracts, etc.

48 Trust and trustworthiness Studies have emphasized the importance of trust –In the workplace –For patients towards health workers Experimental games could: –Provide a way to measure trust and trustworthiness in different framed contexts –See how trusting behaviour differ when played with anonymous players/ nurses with doctors / doctors with themselves, etc.

49 Experiments as measurement tools Quantification of social preferences –altruism, aversion for inequity, trust, time preference, etc. Use the variables to test their association with: –health seeking behaviour (time preferences) –Perceived quality of care (trust) –Providers behaviours (different cooperative behaviours) Objective: –Descriptive –Prescriptive: link with other theories ; test new policies, etc.

50 Health insurance When people are free to choose whether and how they secure their wellbeing, do they make predictable and rational decisions that are consistent with the objective of reducing vulnerability to health risks? Are there differences across individuals that can explain decisions to enroll/not enroll? –Impact of time preferences on decision to enroll in a CBI ? –Impact of risk aversion on propensity to enroll

51 Investigating corruption Barr et al. (2004): the public servants dilemma Setting: Ethiopia, nursing students Objectives: –to investigate the determinants of corrupt behaviour Methods –uses a designed experiment with 3 types of players (monitor, health workers and community members) Findings Embezzlement of resources is affected by –Earnings HWs (small effect) –Observability of embezzlement behaviour and likelihood to be punished –Legitimate monitoring (Election of a member of the community vs. random designation) –Framing increases variance in behaviours suggesting different professional norms

52 Plenty of other possible games ! Games designed to reproduce an existing environment –More complex, specifically designed/tailored –Modelling choices faced by actors in a particular situation –Reproduce incentives and main characteristics of these choices –See which regulations may work better Objectives –To better understand the determinants of behaviours

53 5. Possibilities and limitations of experimental economics What experiments can / cant do Advantages Limitations

54 Experiments are one of many research tools Qualitative methods Surveys: Econometric/statistical analysis of existing data Experimental methods Real-world pilots/trials Each has its relative strengths/weaknesses –Complements, not substitutes

55 When are experiments useful? To reveal or measure social preferences (altruism, trust, etc.) To understand behaviours/phenomena that can hardly be observed in the reality –Measure (relative) values If the data dont exist, then create the data you need –If its never been done, how do you know what works? –Test new policies/ incentives / types of regulatory mechanisms –Preliminary step, before actual pilot study in the field

56 Advantages of Exp Econ (1): enhanced control It is known which variables are exogenous and which are endogenous Many variables that cannot be directly observed in the field can be observed in the lab. –Quantification of reaction to incentives, cut-offs (risk aversion) Subjects are randomly assigned to the treatment conditions – rules out selection bias.

57 Advantages of Exp Econ (2): avoiding some biases Motivation (payment) – avoid potential biases of responses obtained through classic survey instruments which can reflect a purchase of moral satisfaction Language: –neutral phrasing, avoid framing effects that influence answers Double blind –Some designs allow complete anonymity and avoids experimenter effects and other-regarding concerns

58 Example: incentive program (P4P) Experiments could help understand: –Relative efficiency of different types of rewards/sanctions on an experimental outcome –Design of incentive program: individual or group-based and their impact on free- riding/gaming Impact of possibility to observe efforts or not Experiments could not answer: –Magnitude of effect on performance/quality of work, etc. –Which value of incentive for a particular task (WTP, DCE)

59 Example: health insurance Experiments could help understand: –Time preferences of different groups of population –Risk aversion of different types of populations regarding low and high probability events Experiments could not answer: –Which service package would –Which value of premiums could be acceptable (WTP, DCE with service package as well) –Which type of management (community based, facility-based, etc.)

60 Limitations of Exp Econ Internal validity: do the data permit causal inferences? –a research study has internal validity if the outcome is a function of the variables that are measured/ controlled/ manipulated in the study –Therefore internal validity of experiments is a question of proper experimental controls and correct data analysis. The method is not realistic and lack external validity –A research study has external validity if the results obtained would apply to other similar programs or approaches. –Problem of realism of abstract setting / simplistic modelling –Problem of representativity/realism: are experimental subjects representative for out of sample applications?

61 Responses to lack of realism Most economic models are unrealistic in the sense that they leave out many aspects of reality to simplify it... Simplicity as a virtue? –because it enhances our understanding of the interaction of relevant variables. –Because it allows to get at underlying values/ reflexes Whether realism is important depends on the purpose of the experiment. –If testing a theory or understanding the failure of a theory, then the evidence is important for theory building but not for a direct understanding of reality. –If EE is used to better understand real behaviours, then efforts must be made to frame the experiments and make them as close to real as possible

62 Ethical issues Transparency of motives –Even if not being deceptive, usually not honest about motives –When deception is involved, potentially more serious. Inducing decisions –The problem of the size of stakes / bribing Emotional distress –subjects may learn something about themselves not like (selfishness, unacknowledged racist preferences) –Even more problematic when not anonymous (to study effects of social norms)

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