Economics in the Laboratory Daniel Houser Professor of Economics Director, Interdisciplinary Center for Economics Science George Mason University, Fairfax, VA

Ingredients of an Experiment In Double auction, we have: Environment: values, cost, buyer or seller, you can only sell what you have ( property rights). Institution: Starting rule, stopping rule, MSGs: tell auctioneer you ID, your bid/ask, you can only ask smaller than the standing price. Rules: when bid is bigger than asking price, we use the lower price as the purchase price; everything is done with one-unit transaction.

Ingredients of an Experiment In Double auction, we have: Environment: values, cost, buyer or seller, you can only sell what you have ( property rights). Institution: Starting rule, stopping rule, MSGs: tell auctioneer you ID, your bid/ask, you can only ask smaller than the standing price. Rules: when bid is bigger than asking price, we use the lower price as the purchase price; everything is done with one-unit transaction.

Ingredients of an Experiment In Double auction, we have: Environment: values, cost, buyer or seller, you can only sell what you have ( property rights). Institution: Starting rule, stopping rule, MSGs: tell auctioneer you ID, your bid/ask, you can only ask smaller than the standing price. Rules: when bid is bigger than asking price, we use the lower price as the purchase price; everything is done with one-unit transaction.

Ingredients of an Experiment In Double auction, we have: Environment: values, cost, buyer or seller, you can only sell what you have ( property rights). Institution: Starting rule, stopping rule, MSGs: tell auctioneer you ID, your bid/ask, you can only ask smaller than the standing price. Rules: when bid is bigger than asking price, we use the lower price as the purchase price; everything is done with one-unit transaction.

Ingredients of an Experiment In Double auction, we have: Environment: values, cost, buyer or seller, you can only sell what you have ( property rights). Institution: Starting rule, stopping rule, MSGs: tell auctioneer you ID, your bid/ask, you can only ask smaller than the standing price. Rules: when bid is bigger than asking price, we use the lower price as the purchase price; everything is done with one-unit transaction.

Why Experiments? Test a theory. Discriminate between theories. Compare a theory’s message or outcome implications with experimental observations. Example: Dictator Games

Duhem-Quine Thesis One can always rescue a theory from an anomalous observation by ex post hoc recourse in imaginative and persuasive auxiliary hypotheses. This thesis denies the possibility of direct falsification of any specific testable implication of a theory Vernon Smith: Philosophers exaggerated the significance of the Duhem-Quine problems. Experimental economists do new experiments to test the auxiliary hypotheses. If they are not testable, it’s preeminently your critic’s problem.

Flat Maximum Harrison(1992) questioned falsifying observations in experimental economics as due to a postulated lower opportunity cost of deviating from theoretical optimality. Smith and Walker (1993) offered a review of studies testing this proposition. The results show: Money does matter; Factors besides money also matter; Many anomalies do not disappear by escalating payoffs; Inadequate attention has been given to modeling the possible relationship between the performance of a theory and the motivation of decision makers.

Why Experiments? Explore the causes of a theory’s failure. “Establishing the anatomy of failure is essential to any research concerned with modifying the theory”-Vernon Smith Example: Hoffman, McCabe, Shachat and Smith, “Social distance and other regarding behavior in dictator games.”

Why Experiments? Establish empirical regularities as a basis for new theory. Theories rely on simplified assumptions; Experiments make the study of complex environments possible. Example: Double auction (Smith, 1991).

Unconscious Optimization in Market Interactions In many experiments, poorly informed, error-prone, and uncomprehending human agents produce approximate wealth maximizing outcomes. With only private information, subjects converge to the competitive equilibrium quickly in a double auction. Denying their outcome could be predicted, subjects were both surprised and amazed when opening a sealed envelope containing the correctly predicted equilibrium price and quantity (Gillette and DelMas, 1992)

Unconscious Mind: A Better Decision Maker? Economic agents can achieve efficient outcomes which are not part of their intention. – Adam Smith

Why Experiments? Compare environments. Same institution, comparing environments: An investigation of the robustness of the institution. Stress the theory with extreme environmental conditions. Example: Nash equilibrium predicts well in bargaining environment (Fouraker and Siegel, 1963), but breaks down in ultimatum game (Hoffman, 1992)

Why Experiments? Compare institutions. Identical environment but varying market rules of exchange, to establish comparative properties of institutions. Example: What sort of market design leads to efficient trade of electric power?

Why Experiments? Evaluate policy proposals. Examples include Incentives for off-floor trading in double auction; Alternative institutions for auctioning emissions permits; Mechanisms for allocating space Shuttle resources, and airport slots

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