Experimental economics:
market institutions
Stéphane Robin GATE-CNRS
Cargèse – May 2006
Introduction:
Aims of the workshop
The workshop topics:


Market institutions as an important issue
Experimental economics as an appropriate
methodology
Aims of the workshop



To present what is experimental economics
To give the flavor of market experiment
To introduce to experiment use for market design
Structure
About experimental economics




What is it ?
Ingredients of an experiment
What are the purposes of experiment ?
Market experiment: the institution issue
Markets in the lab.




1
2
3
4
-
How to create a market in a lab?
Various market institutions
A simple double auction experiment
Good and bad news from the lab about market
Experiments for market design
Part 1:
About experimental economics
What is it ?
Ingredients of an experiment
What are experiment motivations ?
Market experiment: the institution issue
Experimental economics:
What is it?
Create a manageable
"microeconomic environment in
the laboratory where adequate
control can be maintained and
accurate measurement of
relevant variables guaranteed"
Wilde, 1980 as quoted in Smith, 1982
Experimental economics
Ingredients of an experiment
Environment


Initial endowments, preferences and costs that
motivate exchange.
Environment is controlled through monetary
rewards
Institutions

Market communication offer, acceptance…, rules
of exchange of information and rules for binding a
contracts
Behavior

Human action observed given the control on
environment and institution
What are the purposes of
experiment ?
Test a theory, or discriminate between theories
Explore the causes of a theory's failure
Establish empirical regularities as a basis for
new theory
Compare environments
Compare institutions
Evaluate policy proposals
The lab as a testing ground for institutional
design
Smith, 1994, JEL
Market experiment:
the institution issue
Chamberlin 1948 first market experiment


Decentralized negotiation as a "souk"
Inefficient outcomes compare to partial
equilibrium prediction
Smith 1962 answer



Market institution matter
Continuous oral double auction as centralized
stock exchange
Efficient outcome with a quick convergence to the
partial equilibrium even with small number of
traders
Market experiment:
the institution issue
From the study of well-known institution…


Test, comparison of well-known institutions
Robustness to environment modification market
structure, asymmetric information, externalities…
… to the design of new institution


The lab as a test bed for new institution
Emerging discipline of design economics: design
and maintenance of markets and other economic
institutions.
Part 2:
Market in the lab.
How to create a market in a lab?
Various market institutions
A simple double auction experiment
Good and bad news from the lab about market
How to create a market in the lab.
Let's start with a bilateral exchange
Two individuals, one unit exchange
Induced value theory – Smith 1976
Supply
« Induced value » for
the seller:
ECU 100
« Cost » controlled by
the experimenter
No cost without sale
Demand
« Induced value » for the
buyer:
ECU 300
« Preference » controlled
by the experimenter
The exchange
A potential surplus of ECU 200
Price 100<p<300
Price indeterminate
Institutions matter: ultimatum, dictator,...
Exchange, surplus and
subjects' payment
Let's suppose we have a deal at 150.
Seller surplus: 150 – 100 = 50
i.e contract price minus seller's limit price
Buyer surplus: 300 – 150 = 150
i.e. buyer's limit price minus contract price
Subjects' remunerations depend on the
exchange surplus through exchange rate
Creating a market
Each seller :

Has only one unit of good to sell, with a
fixed cost value
Each buyer :

Has value for only one unit fixed
redemption value
An example:
n individuals, one unit each
11 Buyers :
250
210
200
185
175
168
142
138
135
124
124
10 Sellers :
280
278
210
195
185
172
170
150
142
124
Demand curve
300
250
200
Buyers
150
100
1
2
3
4
5
6
7
8
9
10 11 12
Supply curve
300
250
200
Sellers
150
100
1
2
3
4
5
6
7
8
9
10 11 12
Supply and demand curves
300
250
Buyers
200
Sellers
150
100
1
2
3
4
5
6
7
8
9
10 11 12
Equilibrium and Surplus
Competitive equilibrium market price is in
the tunnel: ECU 172-175
Competitive equilibrium quantity is 5 units
The competitive equilibrium surplus value is
ECU 262 maximum potential profit
Market efficiency rate:
Ratio of the profits earned by subjects in
divided by the maximum profits
Example of offer and demand design for
electricity market experiment
Jullien, Robin, Staropoli, 2000
200
Quasi inelastic
180
demand
160
140
120
100
100
80
70
60
40
Peak load
technology
30
20
0
0
50
100
150
Base load
technology
200
250
300
350
400
450
500
550
Market Institutions
Bilateral Bargaining
Unilateral Auctions

Walrasian
tâtonnement

Sealed-Offers
Oral
Bilateral Auctions
Posted offers


Clearing House
Continuous Oral
Auctions
Continuous Oral Auction: Ask
Auction
Ask auction:
Any seller who makes an ask proposition to sell raises
his hand.
This ask is publicly announced to the market, other
sellers may propose lower prices.
Only the most attractive ask “stands” and can be
accepted.
Prices are high, but competition among sellers
pushes them down.
At any time, a buyer can buy by accepting the
current ask.
Continuous Oral Auction: Bid
Auction
Bid auction:
Any buyer who makes a bid proposition to buy raises
his hand.
This bid is publicly announced to the market, other
buyers may propose higher prices.
Only the most attractive bid “stands” and can be
accepted.
Prices are low, but competition among buyers pushes
them up.
At any time, a seller can sell by accepting the current
bid.
Double auction
Double auction: The two previous auctions are
open in parallel for the same product market.
The improvement rule is so that bids are going up
and asks are going down. Therefore, prices on the
two auctions tend to converge.
Computerised DA. for the lab.: MUDA, IEM
The DA institution is largely used in stock auction
markets e.g. New-York SE.
Double auction:
a simple experiment
Each seller :



Has only one unit of good to sell, with a fixed cost
value
Is only informed of his own induced value
Propose an offer to sell or accept an offer to buy
at any time
Each buyer :



Has value for only one unit fixed redemption value
Is only informed of is own induced value
Propose an offer to buy or accept an offer to sell
at any time
Contract form
Contract form for seller
Period : 1
Id : .......
Contract price (1) ………..
Cost of the unit sell
1000
Profit (1-2): ……...
Contract form
Contract form for buyer
Period : 1
Id : .......
Redemption value
100
Contract price (2) ………..
Profit (1-2): ……...
Contract form
Price
Demand curve
110
105
100
95
90
85
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
102
97
92
87
82
77
72
67
62
57
52
47
42
37
32
0
1
2
3
4
5
6
7
8
Quantity
9
10
11
12
13
14
15
Contract form
Price
Offer curve
110
105
100
95
90
85
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
0
1
2
3
4
5
6
7
8
Quantity
9
10
11
12
13
14
15
Contract form
Price
Offer and demand
110
105
100
95
90
85
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
Competitive equilibrium :
Price beween 55 and 57
Quantity : 10
Total surplus : 470
0
1
2
3
4
5
6
7
8
Quantity
9
10
11
12
13
14
15
Competitive oral double auction
Grenoble-30/03/95a
Noussair, Robin, Ruffieux 1998
Experimental results regarding
the DA market
Quick convergence towards
equilibrium after a series of identical
markets, i.e. a constant initial
endowment of unit values and costs for
each subject.
Efficient allocation
Looking for the limits of
competitive outcomes
Regular or cyclical demand or/and
demand shifts
Random supply or/and demand shifts
Insiders
Multiple, Interrelated Markets
3 - Studying market failures
Monopoly, oligopoly and collusion
Externalities and Public goods
Information asymmetries
Speculation on asset markets, and
“bubbles”
Asset markets
and Speculation
Design:



Traders initially possess cash and units of asset
that they can buy and sell during the session.
At the end of each trading period, the
experimenter monitor draws and announce a
common dividend for all asset units.
The expected value is $.24 equally like
alternatives: $.6, $.28, $.08, $.00
Result: bubbles and cracks
Asset Market:
fundamental values
4
3,5
3
2,5
2
1,5
1
0,5
0
$3,36=14*0,24
$0,24=1*0,24
$3,60=15*0,24
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16
Asset market:
results expected
Few transactions
Market price stuck to fundamental
values
Smith, Vernon L., Gerry L. Suchanek, and Arlington W. Williams.
“Bubbles, Crashes, and Endogenous Expectations in
Experimental Spot Asset Markets.” Econometrica 56, no.
September 1988: 1119-1151.
Asset Market: Grenoble-150999
Asset Market: Grenoble-240999
Part 3:
Experiments for market
design
EE and market design
Research motivated by specific industrial
issues

Lot of them are commissioned by private firm or
public institution for regulation
Using the lab as a test bed for market design

Create in a lab a model which, at the same time,
 captures the principal characteristics of a market
 and is simple enough to be handle in the lab


+ test at low cost, control of the environment
- how to go from the simplicity of the lab to the
complexity of the real market
EE and market design: selected projects
The National Resident Matching Program
 Roth 1991; Roth and Peranson 1999
Airslott allocation
 Grether, Isaac and Plott 1981; Grether, Isaac and Plott
1989; Kreps 1990; Rassenti, Smith and L. 1982; van
Damme 1998
Spectrum auction for communication
 Plott 1997, Abbink et al 2005
Pricing in a Gaz Transportation Network
 Plott 1988
Allocation of the right to use Railways tracks
 Brewer, Plott 1996; Cox et al, 1998
Electric Power Exchanges
 Smith, Wilson and Rassenti
As a conclusion
Market institution matters
Experimental economics is well
adapted for study market rules
There is demand for experimental
research dedicated for market design
Thank you for your attention
[email protected]