RE: experimental economics

["Forstater, Mathew" <ForstaterM@xxxxxxxx>]

Phil Mirowski's forthcoming book, _Machine Dreams_, dispenses with Vernon
Smith's claim with characteristic bite and rigour.  I have seen a couple chs. of
the book, btw, and it should cause a stir at least equal to his _More Heat than
Light_.


-----Original Message-----
From: Michael Perelman [mailto:michael@xxxxxxxxxxxxxxxxx]
Sent: Monday, October 02, 2000 11:54 AM
To: pen-l@xxxxxxxxxxxxxxxxxxx
>Subject: [PEN-L:2579] experimental economics


Last night, I noted in the Journal of Economic Perspectives that one of
the leading experimental economists claimed that their work verified
Hayek's (my voice recognition read this as: high acts) theory of
spontaneous order.  They also take credit for developing the spectrum
auctions, which I suspect are being sold off at less than what they're
worth, despite the auction theorists idea of the winner's curse.

Wall Street Journal - October 2, 2000


Moving Past Rats: More Economists
Study Behavior in Online Experiments

By JOEL ROSENBLATT
Staff Reporter of THE WALL STREET JOURNAL


When 10 homes and nine lots in the Palm Springs, Calif., Bermuda
Dunes development project sold in one hour and 29 minutes, the event
was heralded as one of the highest-value Internet auctions to date.

What the bidders -- and even the developer, real-estate giant Kaufman
& Broad Home Corp. -- didn't know, is that the July auction was in
fact a "field test of theories and models that were actually
developed in the laboratory," according to Charles Plott, professor
of experimental economics at California Institute of Technology in
Pasadena, Calif.

Dr. Plott, the "architect" of the auction, will use the data from
bidders' behavior to refine and test more sophisticated versions. "A
research paper will come out of this," he notes.

For years, experimental economists like Dr. Plott have been relegated
to the sidelines of academia, studying markets and economic theories
in the lab. But in just the past two years, half of the top 10 U.S.
business schools as well as numerous university economics departments
have hired experimental economists. The discipline has started
publishing its own journal, and the number of scholarly treatises
published on the subject skyrocketed to 232 in 1999 from an average
of fewer than 20 per year in the 1970s.

Businesses and government bodies are getting involved.
Hewlett-Packard Co. and International Business Machines Corp. have
opened experimental-economics labs, and the Federal Communications
Commission consults experimental economists for advice on running its
online auctions of airwaves for wireless services. There is even buzz
in economist circles about an experimentalist winning the Nobel Prize.

That's a far cry from the 1970s, when John Kagel, an economics
professor who is now at Ohio State University, started using rats in
his experiments to test various economic theories. One experiment
aimed to dispute the long-held notion that the poor are mired in a
"cycle of poverty" because they save a smaller proportion of their
income than the rich do.

His experiment involved two groups of rats. One group was given four
times the amount of water, and twice as much food, as the other,
creating a fat (rich) group and a thin and hungry (poor) group. Both
groups were then trained to associate behavior at their regular
feedings with amounts of food received: When presented with food,
they could either consume it immediately -- "spending their capital"
-- or wait an interval and receive a greater amount -- "principle
plus interest" -- later.

"The rats who were wealthy, or fatter, went for the smaller, more
immediate reward more often than the rats who were poor, or leaner,"
Dr. Kagel says. He admits that extrapolating such results to humans
from rats raises the same doubts that similar experiments in medicine
and psychology do. But he believes his experiment contradicts the
notion that the rich are instinctively better savers and speaks to
assumptions about poor humans, namely that "it ain't that they've got
screwed-up preferences -- it's that they get screwed all the time."

Early in their struggle for recognition, experimental economists were
criticized for being unable to demonstrate the usefulness of their
results. Today, Internet commerce has helped them over that hurdle.
Harvard University recently appointed Alvin Roth to serve as an
experimentalist liaison between the business school and the economics
department. Dr. Roth and a colleague, Axel Ockenfels, have found that
subtle differences in the rules of an auction -- say, in how it is
concluded -- can profoundly affect bidder behavior. For example,
Internet auctioneers eBay Inc. and Amazon.com Inc. both stipulate the
date and time a given sale will conclude, but Amazon has an added
wrinkle: Whenever a bid is cast in the 10-minute interval before the
Amazon auction is scheduled to end, the auction is automatically
extended for an additional 10 minutes from the time of the latest
bid. This ensures that an Amazon auction can't close until 10
"bidless" minutes have passed.

At eBay, by comparison, potential buyers will often step in at the
last minute, sparking bidding frenzies. Is this simply because these
late bidders have been holding out to avoid driving up the price
early on, as might be expected? Dr. Roth, who consults for Web
companies, believes that to be the case but can't rule out other
variables. To better understand the two groups' behavior, he plans to
run experiments with people in a laboratory.

"We're starting to see the birth of a kind of engineering economics,"
Dr. Roth says of his work. "Having a proliferation of markets on the
Web is great for economics because even markets we don't build we can
study."

Two years ago IBM hired an experimentalist from Hewlett-Packard's
laboratory in Palo Alto, Calif., and last November quietly opened its
own lab at its research center in Yorktown Heights, N.Y. Both
companies have developed proprietary software and use human subjects
-- sometimes managers -- to simulate market environments.

Kay-Yut Chen, a project scientist at Hewlett-Packard, says the lab
allows him to test changes in corporate policy to examine the effect
on market structures before the change is introduced. IBM's senior
manager of research, Robert Baseman, says the company will use its
lab to focus on helping customers build and design markets on the
Internet.

"Before we came along, you had 10 executives who would sit around and
use intuition and reasoning" to make decisions about contracts and
advertising, Mr. Chen says. Using labs can save time and money, he
adds.

Some of the economists' experiments take on the guise of games.
Vernon Smith, a professor at the University of Arizona, is asking
human subjects in a "voluntary trust" game to chose from the
following:

1) You are Person A. You will be given $40, which you must split
evenly with another subject in the experiment -- Person B -- in which
case the game is over.

or

2) You, Person A, present Person B with two choices, involving
different sums: You tell Person B he can take $30 out of $45, leaving
you $15; or he can split $50 evenly between the two of you.

To complete the math, you, as person A, have a sure $20 if you choose
the first alternative; if you go for the second, you will be left
with either $15 or $25, depending on Person B's decision.

The stakes may seem small, but the implications of the choice are
enormous, says Dr. Smith.

If you choose No. 1, you fit the "rational" (read money-hungry) model
that classic economists have traditionally used to predict human
behavior. But Dr. Smith is finding that a majority of people choose
No. 2 -- with good reason, as it turns out, because most of the
people in the role of Person B generously decide to split $50 evenly
instead of taking $30.

What gives? Respect and reciprocation, Dr. Smith says. The second
person in the experiment knows you deferred the decision to him,
thereby giving him a chance to make more money. He returns the favor
by settling for a little less, leaving you with more.

"The standard economic model is one where we're very
self-interested," Dr. Smith says. But, he adds, even among strangers,
"the people who are trusting make more money than those who are not."

Dr. Smith and a colleague, Kevin McCabe, also study
magnetic-resonance imaging scans of people playing this
voluntary-trust game online. By monitoring blood flow to regions of
the brain, they hope to build a physiological model of how economic
decisions are made.

IBM invited Dr. Smith to speak at the dedication of its experimental
lab. The professor didn't mention his brain-scanning experiments but
says he has thought a lot about the connection between the trust
games and IBM's objectives.

The idea of "people interacting in anonymous situations is very
relevant to e-commerce and the Internet," he says. "It's a whole new
world out there among anonymous agents, and we need new institutions
that will allow them to build reputations, so that people can trade
on trust."

--

Michael Perelman
Economics Department
California State University
michael@xxxxxxxxxxxxxxxxx
Chico, CA 95929
530-898-5321
fax 530-898-5901