Experimental economics creates a controlled environment in which many of the unanswered questions about economics may be given careful study. This paper provides a comprehensive analysis of experimental economics and its role in studying the ever-changing global economic system of the 21st century.
Keywords: Dominant Strategy; Dominant Strategy Equilibrium; Nash Equilibrium; Prisoner's Dilemma; Utility Theory
One of the most iconic scientific findings of the early 20th century was Alexander Fleming's discovery of penicillin. As luck would have it, a tiny amount of mold floated up into Fleming's laboratory from a mycology lab one floor below, and landed in an uncovered culture plate in 1928. When Fleming, who was on vacation at the time, returned to his workplace, he discovered the mold and its as-yet unrealized potential, and medical history was made. Years later, he visited another laboratory, one that was modernized and virtually free from contaminants. His host commented on the conditions in which Fleming had toiled and wondered aloud about what extraordinary discoveries Fleming could have made in such a facility. Fleming responded simply: "Not penicillin" ("Serendipity," 2009).
Indeed, science is often broken into two arenas: Laboratory environments in which controlled experiments are conducted and "real-world" settings in which the processes or concepts being studied are allowed to play out in uncontrolled conditions. In the science of economics, the same generalization can be made. On the one hand are the trends that occur and systems that are in operation which are the focus of observant economists. These individuals take such data and establish theoretical frameworks to help explain what transpires. On the other hand are the concepts that may be compiled in theoretical constructs and then applied in real world scenarios.
The latter of these two economic arenas is what is known as "experimental economics." Like Fleming's laboratory (as well as the modernized facility he visited later in life), experimental economics creates a controlled environment in which many of the unanswered questions about economics may be given careful study. This paper provides a more comprehensive analysis of experimental economics and its role in studying the ever-changing global economic system of the 21st century.
A Brief Overview of Experimental Economics
Economics is a science, complete with a wide range of analytical methods and theoretical frameworks. Of course, an arena as dynamic and multifarious as economics has largely been considered difficult to quantify or understand in a controlled environment. Many economists have therefore eschewed this approach, believing that the better avenue is to study economic trends in "real world" settings.
Then again, much of economics focuses on the balance between supply and demand. Demand may be considered the preference of the consumer or, to put it in a psychological context, a matter of individual choice. In 1931, L.L. Thurstone first applied such an approach, employing utility theory (a psychological attempt to ascertain the value, or "utility," of choice) to predict individual choice in consumerism. Several other studies, one in 1944 and two more in 1951 and 1953, supported Thurstone's theory. In fact, studies abounded over the next few decades, culminating in a series of studies in the 1990s that used utility theory to analyze irrational behaviors which could lend to rises in consumption and savings behavior (McKinney & Roth, 2006).
The Rules of the Marketplace
Part of what is being studied in experimental economics are the rules of the marketplace and how they impact the market itself. Over the course of the latter 20th century, economist Vernon L. Smith conducted or oversaw thousands of experiments on social groups and the impact of consumer preference on the markets. He broke down the idea of market trading into simple interactions between individuals. In understanding the nature of consumer behavior, his laboratory studies of individual preference helped policymakers, industrialists, entrepreneurs and fellow economists better gauge consumer behavior. As Smith, a 2003 Nobel Prize winner, succinctly said, "The benefits of market exchange are easy to see in personal interactions, where you do something for me and I do something for you," he said, adding, "Out there in 'markets,' though, they're not always clear. If the price goes up, the oil companies get more money and I have less. That's the average person's perception and experience. Experimental economics helps put a human face on markets" (Gillespie & Lynch, 2002).
Smith's approach stemmed from his experience working with Edward Chamberlin. Chamberlin had become cynical of the predictability of the markets during the Great Depression, an era in which such understanding was absolutely necessary. Chamberlin focused on three areas.
- The first was a streamlined version of the natural markets.
- The second was a laboratory interpretation of the markets, in which the various subcomponents could be separated and applied in a number of game experiments.
- The third of these areas consisted of individual experiments; putting a focus on a microscopic level and analyzing patterns of individual choice for reapplication into market scenarios.
Through these market experiments (which entailed the employment of a number of test subjects — namely Chamberlin's graduate students, of whom Vernon Smith was one), Chamberlin constructed a number of early theories about consumer choice that would ultimately inspire Smith's later works (Davis & Holt, 1993).
Experimental economics is not employed to explain large, complex trends and systems in a given market. Rather, it is used to help analyze specific elements of a given system and, as a result, help explain how those elements contribute to the whole system in question. As California Institute of Technology Professor Charles Plott said in a 2008 interview:
We create experiments that do not mirror the world around us because it is too complex … Instead, we design very simple experiments that allow us to see the theory clearly, separating the accurate from the inaccurate, and then the question is: Does that theory that we have seen clearly in a simple case actually help us understand a more complex case?
An important aspect of experimental economics is the use of modeling. Modeling entails placing elements of a given study area into a controlled framework in order to see how these parts interact. Models are general vehicles, to be sure, but have the potential to be flexible as internal elements are modified, supplemented or reduced in number.
Modeling has become a popular form of experimental economic analysis, particularly among large companies and governments who seek to maximize returns on investments, business practices or changes to policymaking strategies. In the modern era, computer technology has helped immeasurably to connect large quantities of complex and multifarious data into a working system whose parts' contributions can be studied individually or in the aggregate.
The use of models in experimental economics has caught on in many corporations who not only seek maximum return on investments and strategies, but to locate flaws or loopholes in their current endeavors. Models could be used to determine the optimum time to introduce...
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