An Introduction to Market Experiments

Catherine EckelUniversity of Texas at Dallas

Introduction Market experiments = laboratory

for policy testing and development Hard to visualize what experiments

are like without seeing one This auction is an example of one

of the earliest and most powerful experiments

Overview of Experiment Each table is a trading team in the

experiment - buyer or seller Make decisions about your trading

strategy as a group between rounds Designate one person as the “trader”

to act for your group during the trading periods

Sellers Each seller receives a cost of production

Your cost is the number on your record sheet Costs are reallocated each round

Sellers make money by selling above their cost

Remember: Your objective is to earn as much profit as you can

If your unit sells, you earn price – cost. Otherwise you earn 0. If you do not sell you do not incur production cost

Buyers Each buyer has a reservation value

Your value is the number on your record sheet Values are reallocated each round

Buyers make money by buying below their value

Remember: Your objective is to earn as much profit as you can

If you buy a unit, you earn Your Value – Price. Otherwise you earn 0. You do not make a profit on unbought units

The Market

All buyers and sellers receive values, costs At any time, a buyer can raise his bidding card

and when recognized say “Buyer X bids ___” At any time, a seller can raise her bidding card

and when recognized say, “Seller Y offers ___” Bids and offers are recorded by the recorder Bids have to improve on previous bids, and offers

have to be lower than the previous offer.

The Market, cont’d. At any time, any buyer can accept the

outstanding offer (raise your card!) At any time, any seller can accept the

outstanding bid (raise your card!) When a buyer and seller agree a sale is

made. Write down on your record sheet your price and profit.

Then all bids and offers are automatically withdrawn.

The market ends when there are no more trades, or 4 minutes, whichever comes first.

Your record sheet: SellersRound 1:

My Cost: (indicated on the form)

My unit sold YES NO

My Price: ____

Profit: ________

Highest selling price________

Number of units traded ____________ Lowest selling price__________ Comments:

Record: whether your unit sold, the price you sold it for, and your profit (price - cost).

In the bottom of the form record information for the round, including any comments

Your record sheet: BuyersRound 1:

My Value: (indicated on the form)

My unit sold YES NO

My Price: ____

Profit: ________

Highest selling price________

Number of units traded ____________ Lowest selling price__________

Comments:

Record: whether you bought a unit, the price you bought it for, and your profit (value - price).

In the bottom of the form record information for the round, including any comments

Fill out your record sheet Use one box for each round Notice your cost or value (it will change each

round) When your unit sells, fill out price Record whether your unit sold and calculate

profit Record market information

High and low price Units sold

Comments space lets you record particular things about this round.

How the experiment will go

The floor will open Bids must go up, offers must come down When a bid and offer agree (or a bid or offer are

accepted) a trade is made All outstanding bids and offers are withdrawn, and

the floor reopened. If you traded your unit, you are done for this round If you did not trade your unit, you may still trade When there are no more trades the market closes We will do several rounds of the market Costs and values are “reshuffled” each round to give

everyone a chance to earn money.

Remember Buy low and Sell high Try to make as much money as

you can

Envelope contains the “prediction”

What did we do?

Reproduced a market in the lab! Sellers had induced costs Buyers had induced values Implemented a specific trading

institution Oral Double Auction

When we collect data people are paid what they earn.

Auction Market: Demand and Supply

0

50

100

150

200

250

0 1 2 3 4 5 6 7 8 9

Units

Pri

ce

Reservation Values

Cost

Auction Market: Demand and Supply

0

50

100

150

200

250

0 1 2 3 4 5 6 7 8 9

Units

Pri

ce

Reservation Values

Cost

Equilibrium Price: $150

Auction Market: Demand and Supply

0

50

100

150

200

250

0 1 2 3 4 5 6 7 8 9

Units

Pri

ce

Reservation Values

Cost

Equilibrium Price: $150

Equilibrium Quantity: 7 units

What Else Can You Do With this Market? Examine the effects of policy

changes Taxes Quotas Tariffs Price Ceilings and Floors

Examine the results of changes in supply and/or demand by changing seller costs and buyer values

Results of a Double Auction Market Experiment

Double Auction

0

10

20

30

40

50

60

70

80

90

100

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Period

AvPriceG1

AvPriceG2

What else can you do? Compare trading “institutions”

Differences in the rules for trading Example: What is the effect of rules that

prohibit insider trading? Design new markets

Economic engineering: wind tunnel design Example:

Markets for pollution permits “Smart” market for wholesale electricity

“Take home” message: Markets can be reproduced in the lab Double auction lab markets converge

quickly to competitive equilibrium Lab markets can be used to test

theories or examine policies Lab markets can be used for “wind

tunnel” design of new markets