The Art of Experimental Economics

Twenty Top Papers Reviewed

Gary Charness, Mark Pingle

• Publisher: Routledge
• Year: 2021
• ISBN:
  9781000423020
• Edition: 1
• Topic: Economics
• Subtopic: Microeconomics
• Index: Economics

Applying experimental methods has become one of the most powerful and versatile ways to obtain economic insights, and experimental economics has especially supported the development of behavioral economics. The Art of Experimental Economics identifies and reviews 20 of the most important papers to have been published in experimental economics in order to highlight the power and methods of this area, and provides many examples of findings in behavioral economics that have extended knowledge in the economics discipline as a whole.

Chosen through a combination of citations, recommendations by scholars in the field, and voting by members of leading societies, the 20 papers under review – some by Nobel prize-winning economists – run the full gamut of experimental economics from theoretical expositions to applications demonstrating experimental economics in action. Also written by a leading experimental economist, each chapter provides a brief summary of the paper, makes the case for why that paper is one of the top 20 in the field, discusses the use made of the experimental method, and considers related work to provide context for each paper. These reviews quickly expose readers to the breadth of application possibilities and the methodological issues, leaving them with a firm understanding of the legacy of the papers' contributions.

This text provides a survey of some of the very best research in experimental and behavioral economics and is a valuable resource for scholars and economics instructors, students seeking to develop capability in applying experimental methods, and economics researchers who wish to further explore the experimental approach.

1

INTRODUCING 20 TOP PAPERS AND THEIR REVIEWERS

Gary Charness and Mark Pingle

DOI: 10.4324/9781003019121-1

Smith, V. L., 1962. An experimental study of competitive market behavior. Journal of Political Economy 70, 111–137.
(Reviewed by Charles A. Holt)

Smith (1962) considers the question, “To what extent does competitive market theory predict the behavior and outcomes of heterogeneous buyers and sellers freely trading with each other in an oral double auction?” To examine this question, Smith conducted a series of experiments in which human subject buyers and sellers can interact and trade. Buyers are heterogeneous because they are endowed with a maximum willingness to pay that differs across the population. Sellers are heterogeneous because they are endowed with a minimum willingness to pay that differs across the population. A buyer earns consumer surplus by buying at a price below the reservation price, and a seller earns profit by selling at a price above her reservation price. Competition is instituted through an oral double auction where, during a trading period, a buyer can seek a seller by calling out “buy at __” and a seller can seek a buyer by calling out “sell at __.” In general, Smith finds that competitive market theory predicts extremely well the price and quantity bought and sold by the experimental human subjects, and repeated interactions in a stable environment lead to a reduction in the variability of prices agreed upon by subjects.

In his review, Charles Holt notes how Smith’s framework was comparable to but also different from an earlier version provided by Edward Chamberlin. While Smith (1962) is known for demonstrating the mechanism of the competitive market, Holt identifies one of the Smith (1962) treatments as being especially interesting for demonstrating how a change in the market institution can change the results. Holt provides examples of how Smith and other scholars, including Holt himself, have provided insight for policy by learning how experimental results vary when the market institution is varied. More generally, this work has evolved into what experimentalists now call “mechanism design.”

Holt also describes how the early work of Smith has influenced the experimental methods used today, contributing to Smith deserving the Nobel prize.

Finally, Holt contrasts the earlier work of Smith, which demonstrates the efficiency of markets for experimental goods analogous to consumer nondurables, to later work, which demonstrates the inefficiency of markets for experimental goods that are analogous to durable assets. This contrast demonstrates the power of experimental economics in terms of examining how changes in the decision environment can yield changes in behavior that provide theoretical and policy insights.

Selten, R., 1967. Die Strategiemethode zur Erforschung des eingeschrankt rationalen Verhaltens im Rahmen eines Oligopolexperimentes. In: Sauermann, H. (Ed.). Beiträge zur experimentellen Wirtschaftsforschung, Vol. I. Tübingen: J.C.B. Mohr (Paul Siebeck), 103–168.
(Reviewed by Claudia Keser and Hartmut Kliemt)

The Selten (1967) paper is the only one chosen for this volume that does not have a translation available in English. Its title in English is “The strategy method for researching boundedly rational behavior in the context of an oligopoly experiment.” In this paper, Reinhardt Selten considers the question,

How can we identify a decision maker’s decision criteria that might arise in the play of a game when all contingencies are not explicitly presented, and in particular how will an oligopolist tend to price its product contingent upon the choices of other oligopolists?

To answer this question, Selten had students play an oligopoly game he designed. His primary concern was not the results. His focus was on how the human subjects made their decisions. To identify the strategies used, Selten instructed the student subjects on how to present their strategies in flow charts. He found subjects tended to focus on pricing their product near those of competitors – a boundedly rational action.

In their review, Claudia Keser and Hartmut Kliemt (hereafter KK) begin by providing context for the Selten paper. Selten and his colleague Heinz Sauermann had been studying bounded rationality for years. KK explain that Selten developed the strategy method as part of an effort to identify and understand the processes by which people make decisions.

KK emphasize that the strategy method introduced in Selten’s (1967) paper was not as refined as most applications of the strategy method are today. Selten’s (1967) game was not precisely defined, so the strategies expressed by subjects were not chosen from a limited set of possibilities. A primary purpose of Selten, whose interest was bounded rationality, was to see what elements of the environment subjects would use and what elements they would ignore. For Selten, KK emphasize, the strategy method was a tool for how decision makers represent information. Modern variants of the strategy method, in contrast, amplify information collection by asking subjects to provide contingent responses for the varying possible decision situations.

KK note that researchers often cite the Selten (1967) paper in contexts where the research is seeking to identify the plans of the decision maker and not just the choices, but KK suggest researchers underappreciate the contribution the paper makes to understanding bounded rationality. The strategy method facilitates the development of bounded rationality theories that are data-driven, based upon how people actually make decisions, an attractive alternative compared to developing as-if theories derived entirely from simplified assumptions.

Güth, W., Schmittberger, R., Schwarze, B., 1982. An experimental analysis of ultimatum bargaining. Journal of Economic Behavior and Organization 3(4), 367–388.
(Reviewed by Brit Grosskopf and Rosemarie Nagel)

Guth et al. (1982), hereafter GSS, consider the question, “Will human subjects behave optimally in an ultimatum bargaining situation, and if they do not then why not?” An ultimatum bargaining situation is one where an amount of wealth is to be split between two parties and the last decision-maker in the bargaining process has the choice of either accepting or rejecting the split offered by the other party.

To examine their question, GSS introduce and examine variations of what experimental economists now call the “ultimatum bargaining game.” The first mover in this game decides how much of a bargaining surplus to keep for themselves, and how much to offer to the second mover. The second mover then decides whether to accept or reject the proposed split. If the proposed split is accepted, then the two players receive what was proposed. If the proposal is rejected, then both players receive nothing. Since something is better than nothing, the assumption of material self-interest indicates the second mover should accept any split where they receive a positive amount. Knowing this, the predicted proposal for the first mover is that which offers the second mover the minimum possible amount. GSS found that actual decision behavior was not as extreme as optimizing pure material self-interest indicates. They interpret second mover willingness to reject small positive amounts as a willingness to punish unfairness. First mover offers that are not as extreme as self-interest predicts can then be explained as first movers recognizing that second movers care about fairness, in addition to wealth.

In their review, Grosskopf and Nagel, hereafter GN, emphasize the importance of the ultimatum bargaining game and GSS’ contribution to motivating further research. GN note that the ultimatum game is especially useful because it effectively captures the final-stage ultimatum aspect of every more complicated multi-stage bargaining process. GN then proceed to describe the methodology of the GSS experiments, usefully critiquing some of the methods GSS used then, explaining why they may not be used today. Conversely, GN also recognize some methods GSS used then that experimentalists today should perhaps use more often.

GN describe in some detail the results of the GSS experiments. They then review much subsequent, related research, drawing upon insights they obtained from direct communication with Werner Güth. GN identify studies that vary the GSS experimental procedures, that use the ultimatum game in neuroeconomics and psychology studies, that vary the subject pool, and that use the ultimatum game to develop behavioral theories and examine learning. In their conclusion, GN identify many other important games in experimental economics directly inspired by the ultimatum game, or indirectly related. They emphasize that the ultimatum game has attained lasting importance because of its simplicity and its ability to shed light on important behavioral phenomena.

Kagel, J. H., Levin, D., 1986. The winner’s curse and public information in common value auctions. American Economic Review 76(5), 894–920.
(Reviewed by Gary Charness)

Kagel and Levin (1986), hereafter KL, consider the question, “Can we provide evidence of the winner’s curse in the laboratory with experienced bidders?” To examine this question, KL conduct a lab experiment using a pool of human subjects who have previously played a first-price common value auction game and who have done reasonably well (i.e., not gone bankrupt). Other issues include how increasing the number of experienced bidders or providing public information affect the outcomes of a first-price common value auction. The subjects play the auction game in a smaller group of three to four subject bidders but also in a larger group of six to seven bidders.

In a first-price auction, the winner earns the difference between the common value of the item and the winner’s high bid. The outcomes of auctions for real world oil leases and auctions conducted with inexperienced subjects in labs suggest that this winner’s curse often occurs, with poor results for the bidders. Nash Equilibrium theory indicates that experience and public information about the value of the item should reduce the prevalence of the winner’s curse, while bids should be reduced when there are more bidders. Consistent with theory, KL find that experienced subjects in small groups are less subject to the winner’s curse, and the introduction of public information increases the earnings of the winner when there is no winner’s curse. However, in contrast with theory, KL find that an increase in the number of bidders increases the curse, and an increase in public information reduces the earnings of the winner in this environment.

In his review, Gary Charness begins by emphasizing that the KL paper is path-breaking because it derives a well-defined equilibrium reference point against which the experimental outcomes can be compared. Charness presents the experiment and its results in significant detail, concluding that the results in the KL paper are important because they indicate the winner’s curse is a persistent behavioral anomaly.

As Charness presents in some detail, the KL paper has motivated substantial additional research aimed at understanding the winner’s curse. It appears the cause of the curse is that bidders focus too much on the fact that a higher bid increases the likelihood of winning, while at the same time they do not focus enough on the likelihood that the willingness to bid higher winning is because one has received a higher private signal of the item’s value. Charness gives KL credit for generating interest in how people frame problems like those they confront in the common value auction and, more generally, for helping inspire research in contingent reasoning and hypothetical thinking.

Isaac, R. M., Walker, J. M., 1988. Group size effects in public goods provision: The voluntary contribution mechanism. Quarterly Journal of Economics 103, 179–199.
(Reviewed by James Andreoni)

Isaac and Walker (1988) consider the question, “How do group size and individual marginal return affect the willingness to voluntarily contribute to the provision of a public good?” Their experiment uses a voluntary contributions mechanism with treatments that vary the group size and the marginal return. They find that group size significantly decreases the willingness to contribute to the public good when the individual marginal return is low but not when it is high. They argue that the marginal per capita return is a key factor determining contributions.

In his review, Jim Andreoni opines that the Isaac and Walker paper is a top paper because it forced the profession to “see an old topic with new eyes.” Previous research had led to a near consensus that only small groups can produce coercive mechanisms sufficient to overcome the incentive to free-ride. By showing the marginal individual return from a public-good contribution influences the contribution rate, Isaac and Walker showed that group size is not all that matters.

Andreoni also judges the Isaac and Walker paper important because it raised more questio...

Table of contents

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Table of Contents
• Dedication
• List of figures
• List of tables
• List of contributors
• Foreword
• Preface
• Acknowledgments
• 1 Introducing 20 top papers and their reviewers
• 2 An experimental study of competitive market behavior (by Vernon L. Smith)
• 3 The Strategy Method as an instrument for the exploration of limited rationality in oligopoly game behavior (Strategiemethode zur Erforschung des eingeschränkt rationalen Verhaltens im Rahmen eines Oligopolexperimentes) (by Reinhard Selten)
• 4 An experimental analysis of ultimatum bargaining (by Werner Güth, Rolf Schmittberger, and Bernd Schwarze)
• 5 The Winner’s Curse and public information in common-value auctions (by John H. Kagel and Dan Levin)
• 6 Group-size effects in public goods provision: The voluntary contributions mechanism (by R. Mark Isaac and James M. Walker)
• 7 Rational expectations and the aggregation of diverse information in laboratory security markets (by Charles R. Plott and Shyam Sunder)
• 8 Experimental tests of the endowment effect and the Coase theorem (by Daniel Kahneman, Jack L. Knetsch, Richard H. Thaler)
• 9 Bargaining and market behavior in Jerusalem, Ljubljana, Pittsburgh, and Tokyo: An experimental study (by Alvin E. Roth, Vesna Prasnikar, Masahiro Okuno-Fujiwara, and Shmuel Zamir)
• 10 Unraveling in guessing games: An experimental study (by Rosemarie Nagel)
• 11 Trust, reciprocity, and social history (by Joyce Berg, John Dickhaut, and Kevin McCabe)
• 12 Cooperation and punishment in public goods experiments (by Ernst Fehr and Simon Ga¨chter)
• 13 A fine is a price (by Uri Gneezy and Aldo Rustichini)
• 14 Giving according to GARP: An experimental test of the consistency of preferences for altruism (by James Andreoni and John Miller)
• 15 Risk aversion and incentive effects (by Charles Holt and Susan Laury)
• 16 Does market experience eliminate market anomalies? (by John A. List)
• 17 Promises and partnership (by Gary Charness and Martin Dufwenberg)
• 18 The hidden costs of control (by Armin Falk and Michael Kosfeld)
• 19 Do women shy away from competition? Do men compete too much? (by Muriel Niederle and Lise Vesterlund)
• 20 Group identity and social preferences (by Yan Chen and Sherry X. Li)
• 21 Lies in disguise – an experimental study on cheating (by Urs Fischbacher and Franziska Föllmi-Heusi)
• Index