Experimental Economics - Steve Tucker


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Experimental Economics - Steve Tucker

  1. 1. Introduction to Experimental Methods in Economics Research Steven Tucker Department of Economics and Finance University of Canterbury
  2. 2. A Young and Rapidly Growing Field
  3. 3. 2002 Nobel Prize in Economic Studies Vernon L. Smith Daniel Kahneman for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms
  4. 4. What is Experimental Economics? <ul><li>Experimental Economics is an empirical tool that enables economists to understand the extent to which an individual’s decision and behavior are affected by various (testable) factors in controlled, specifically designed environment. </li></ul><ul><ul><li>Qualitative Methods </li></ul></ul><ul><ul><li>Econometrics/statistical analysis of existing data or new data collected via surveys </li></ul></ul><ul><ul><li>Experimental methods </li></ul></ul><ul><ul><ul><li>Lab and/or Field </li></ul></ul></ul><ul><ul><li>Each has its relative strengths/weaknesses </li></ul></ul><ul><ul><ul><li>Compliments, NOT substitutes. </li></ul></ul></ul>
  5. 5. What is Experimental Economics? <ul><li>“ The trick is to notice that economies created in the laboratories might be very simple relative to those found in nature, but they are just as real. Real people motivated by real money make real decisions, real mistakes and suffer real frustrations and delights because of their real talents and real limitations.” Professor Charles Plott </li></ul>
  6. 6. What is Experimental Economics? <ul><li>Typology of economic experiments (Harrison & List, JEL, 2004) </li></ul><ul><li>Conventional lab experiment </li></ul><ul><ul><li>Standard subject pool of students </li></ul></ul><ul><ul><li>Abstract framing </li></ul></ul><ul><ul><li>Imposed set of rules </li></ul></ul><ul><li>Artefactual field experiment </li></ul><ul><ul><li>Like a conventional lab experiment, but a non-standard subject pool </li></ul></ul><ul><li>Framed field experiment </li></ul><ul><ul><li>Same as an artefactual field experiment, but field context in either the commodity, task, or information set that the subjects can use </li></ul></ul><ul><ul><li>Natural Field Experiment </li></ul></ul><ul><ul><li>Same as a framed field experiment, but the environment is one where the subjects naturally undertake these tasks and the subjects do not know that they are in an experiment. </li></ul></ul>
  7. 7. NZEEL Brand new state-of-the-art, unique to NZ, dedicated research facility 36 terminals Private observation/control room Specialized software with programmers
  8. 8. Objectives of Experiments <ul><li>Testing theories </li></ul><ul><li>Searching for facts </li></ul><ul><li>Testing institutions and environments </li></ul><ul><li>Whispering in the ears of princes: policy advice and wind tunnel experiments </li></ul><ul><li>Replication of previous work </li></ul><ul><li>Teaching economics </li></ul>
  9. 9. Objectives of Experiments <ul><li>1. Testing theories </li></ul><ul><ul><li>Under precisely controlled and/or measured conditions that are typically unavailable in field data </li></ul></ul><ul><ul><ul><li>Is a theory empirically valid? </li></ul></ul></ul><ul><ul><li>The experimental economic lab settings are simple, which allows the reasons for a model’s failure to be isolated and perhaps measured. </li></ul></ul>
  10. 10. Objectives of Experiments <ul><li>Testing theories, con’t </li></ul><ul><ul><li>There are A LOT of theories!!! </li></ul></ul><ul><ul><ul><li>Experiments can help to weed out ones that don’t even work in simple cases </li></ul></ul></ul><ul><ul><ul><ul><li>If the theory doesn’t work under ideal conditions in the lab, it will certainly not work in the field. </li></ul></ul></ul></ul><ul><ul><ul><li>Provide empirical evidence to allow for the improvement of theoretical models. </li></ul></ul></ul>
  11. 11. Objectives of Experiments <ul><li>2. Searching for facts </li></ul><ul><ul><li>To establish empirical regularities as a basis for new theories </li></ul></ul><ul><ul><ul><li>E.g. behavior in gift-exchange games -> models of reciprocity </li></ul></ul></ul><ul><ul><li>To direct theorists’ effort in developing empirically relevant theories </li></ul></ul><ul><ul><li>In the presence of multiple equilibria experiments might help to select the relevant ones </li></ul></ul>
  12. 12. Objectives of Experiments <ul><li>3. Testing institutions and environments </li></ul><ul><ul><li>Compare environments within the same institution </li></ul></ul><ul><ul><ul><li>How robust are the results across different environments? </li></ul></ul></ul>
  13. 13. Objectives of Experiments <ul><li>3. Testing institutions and environments </li></ul><ul><ul><li>Compare institutions within the same environment </li></ul></ul><ul><ul><li>Experiments allow for welfare comparisons of institutions </li></ul></ul><ul><ul><ul><li>E.g. comparison of English, Dutch, first and second price sealed bid auctions, comparison of posted (retail) pricing with double auction trading </li></ul></ul></ul><ul><ul><ul><li>E.g. various institutions within the VCM framework – allowing for punishment/reward, taxes, competition, etc. </li></ul></ul></ul>
  14. 14. Objectives of Experiments <ul><li>4. Policy Advice and Wind Tunnel Experiments </li></ul><ul><li>What would happen if one changed policy or implemented a new institution? </li></ul><ul><ul><li>Effect of reduction of entry barriers on aggregate welfare </li></ul></ul><ul><ul><li>How should airport slots be allocated? </li></ul></ul><ul><ul><li>Environmental Regulation </li></ul></ul><ul><ul><ul><li>Auctions to improve environmental protection and reduce non-point pollution </li></ul></ul></ul><ul><ul><ul><li>Do emission permits allow efficient pollution control? </li></ul></ul></ul><ul><ul><li>Remedies to decrease (or eliminate) insurance fraud </li></ul></ul><ul><ul><li>Wholesale markets for electricity </li></ul></ul><ul><ul><li>What is the most efficient deposit insurance system (if any)? </li></ul></ul>
  15. 15. Benefits of Experimental Economics <ul><li>Replicability </li></ul><ul><ul><li>Provides the basis for statistical tests. Critics can run their own experiments. </li></ul></ul><ul><li>Control over the economic environment and data generating process </li></ul><ul><ul><li>Possibility of implementing truly exogenous ceteris paribus changes </li></ul></ul><ul><ul><li>E.g. we have the ability to double the number of demanders in a market </li></ul></ul><ul><li>Reproduce the structure of theoretical models </li></ul><ul><ul><li>E.g. in the area of International Trade, can’t typically find a “two country world” in field data, but can be created in the laboratory </li></ul></ul><ul><li>Observe variables not observable in field data </li></ul><ul><ul><li>E.g. autarky price (no trade) data are typically not available in the field </li></ul></ul><ul><ul><li>E.g. insurance fraud unobservable by nature, but we can observe it in the lab </li></ul></ul><ul><li>5. Revenue/Cost reduction! </li></ul>
  16. 16. Benefits of Experimental Economics <ul><li>Economics experiments to design and testbed new allocation mechanisms and regulations require financial resources. </li></ul><ul><ul><li>These costs can be thousands of $$, BUT the gains in the field (or avoided losses due to testbedding a theory first) can be in the hundreds of thousands to millions!! </li></ul></ul>
  17. 17. Consequences of not test-bedding. <ul><li>New Zealand spectrum auctions 1990 </li></ul><ul><ul><li>Adopted a second price auction to sell spectrum rights. </li></ul></ul><ul><ul><li>The major problem was that they did not take into account the thin markets within NZ </li></ul></ul><ul><ul><ul><li>Top bid of $100K, but only paid $6 (second highest bid) </li></ul></ul></ul><ul><ul><ul><li>Top bid of $7m, but only paid $5000 </li></ul></ul></ul><ul><ul><ul><li>Top bid of $1, but paid $0 (no other bidders!) </li></ul></ul></ul><ul><ul><ul><li>The auction did not impose reservation prices, which would have substituted for the missing bidding competition. </li></ul></ul></ul><ul><ul><li>The National Economic Research Associates (NERA) who advised this market mechanism initially estimated revenues of $240 million </li></ul></ul><ul><ul><ul><li>The actual revenue was only $36 million (1/7 th the prediction) </li></ul></ul></ul><ul><ul><ul><li>Source: McMillan (JEP, 1994) </li></ul></ul></ul>
  18. 18. Concluding <ul><li>Experimental economics is a powerful research tool to help further develop knowledge in economics. </li></ul><ul><ul><li>Assists in identifying empirical regularities and thus stimulate new research </li></ul></ul><ul><ul><li>Allows for replication in order to verify the robustness of the scientific results from experiments. </li></ul></ul><ul><ul><li>We can study the effects of different institutional environments as defined by their rules and incentive. </li></ul></ul><ul><ul><li>The precise observation of human behavior forces the researcher to take issues of human motivation and bounded rationality more seriously. </li></ul></ul>
  19. 19. Thank you!