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Market Experiments: TheLaboratory versus theClassroomRobert DeYounga

a Beloit CollegePublished online: 10 Jul 2014.

To cite this article: Robert DeYoung (1993) Market Experiments: The Laboratory versusthe Classroom, The Journal of Economic Education, 24:4, 335-351

To link to this article: http://dx.doi.org/10.1080/00220485.1993.10844804

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Market Experiments: The Laboratory versus the Classroom

Robert DeYoung

The first economics article based on results from a laboratory market experi­ment was a study of imperfect competition by Chamberlin (1948). Despite the advantages that experimental methodology seemed to promise for research econ­omists, over a decade passed before the methodology reappeared in the literature. Laboratory experiments by Hoggatt (1959) and Sauermann and Selten (1960) tested and found support for the Coumot model of oligopoly behavior. Smith (1962) first observed that the laws of competitive supply and demand work in the laboratory. In the course of investigating oligopoly and bilateral monopoly mar­kets, Fouraker and Siegel ( 1963) developed experimental techniques that are still being used today. Over the past three decades, the number of economists testing theory by creating marketplaces in the laboratory has continued to increase.

The advantages of working in a controlled laboratory environment can be sub­stantial. Market structures can be designed to match exactly those required by the theory being tested. Because the researcher is sure that the ceteris paribus assumption will not be violated, sophisticated econometrics is usually unneces­sary to extract useful tests of hypotheses. Availability of data does not constrain the researcher because a laboratory experiment can be replicated again and again. The ability to rerun experiments allows researchers to test many special cases of a general theory, to test alternate theories against one another, and also to test for the robustness of a theory under different market structures.

Experimental markets hold substantial advantages for teachers and students of economics as well. Chamberlin (1948) wrote of the pedagogical benefits of mar­ket experiments. Joseph ( 1965) and Joseph and Saunders ( 1970) reported on classroom experiments similar to the one presented in this article; the former con­tains a remarkably timeless passage on the trouble students experience applying economic theory to policy problems. Walker (1987) provided a fascinating, al­though somewhat anthropomorphic, classroom exercise that demonstrates by way of laboratory results how fundamental rational behavior is to human actors. After years of systematic application, Wells ( 1991) drew a crucial distinction for in­structors who use experiments in the classroom: traditional textbooks focus on

Robert DeYoung completed this project while an assistant professor of economics and management at Beloit College. He is presently a financial economist at the Office of the Comptroller of the Currency. The views expressed here are the author's and do not represent those of the Office of the Comptroller of the Currency. The author is indebted to Donald Wells, Arlington Williams, and the National Science Foundation for introducing him to experimental economics; the Joyce Foundation for reducing the opportunity cost of this project; Jerry Gustafson and Mark Walbert for their reflective remarks and encouragement; and two anonymous referees for their comments.

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equilibrium and market structure, whereas classroom experiments inevitably fo­cus on the equilibrating process and market behavior.

This article introduces the uninitiated reader to competitive market experi­ments, makes a renewed case for their use in teaching the competitive market model, and proposes an expanded format for reporting experimental results that is more appropriate for the classroom than the reporting format now generally used. The proposed format reconciles the techniques generally used to test the competitive model with the conditions facing instructors who use experiments to teach the competitive model.

A COMPETITIVE MARKET EXPERIMENT

The most frequently performed market experiments have tested whether (and how) competitive markets clear. In the laboratory, markets with competitive struc­tures converge to the stable and efficient equilibria predicted by economic theory with remarkable regularity (Plott 1989). This robustness makes competitive mar­ket experiments a natural and potentially powerful teaching tool. I describe here the procedures for running a version of a competitive market experiment that works easily and performs well in the classroom. It is my intention to provide instructions comprehensive enough for any instructor to run this experiment in the classroom, but instructors are encouraged to read the relevant sections of Plott (1982, 1524-1525, and 1989, 1171- 1173), which include the preexperiment in­structions read by market experimenters.

Imagine a market experiment involving 18 human subjects. Half of these sub­jects are designated as sellers of an imaginary good and half as buyers of an imaginary good. A unique reservation price is assigned to each subject (Table I) . Each reservation price is private information, known only by that subject. Each buyer's reservation price represents the price at which the good can be resold should the buyer be able to acquire it from a seller. Each seller's reservation price represents the marginal cost of selling one unit of the good. (This cost is incurred only if the seller completes a sale, i.e., as if the sellers take orders for a good now

Seller number

I 2 3 4 5 6 7 8 9

336

Seller cost (reservation price)

($)

5.32 5.49 5.62 5.89 6.01 6.27 6.39 6.44 6.50

TABLE I Reservation Prices

Buyer number

2 3 4 5 6 7 8 9

Buyer resale (reservation) price

($)

7.89 7.43 7.02 6.47 6.09 5.84 5.73 5.66 5.62

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and deliver the good at a later date.) Note that, in the absence of market power, differentiated products, or asymmetric information, economic theory predicts an equilibrium with five trades at a price between $6.01 and $6.09.

A concise set of instructions are read to the participants prior to the experiment. Over the years, uniform instructions have evolved that facilitate replication of laboratory procedures across experiments. A generation of researchers have crafted the instructions to avoid influencing subjects' behavior. These instructions are summarized below. Plott ( 1982, 1989) provided word-for-word instructions for experiments similar to the one discussed here.

Each buyer and seller receives his or her reservation price on a slip of paper similar to those shown in Table 2. Sellers receive the top version of the slip, and buyers receive the bottom version. Participants are told that their reservation price is private information that is not to be revealed to anyone prior to or during the experiment. Trading is completely voluntary. Each subject is told that he or she can make only a single transaction, for which he or she will receive a monetary reward. Monetary rewards are a necessary incentive for trading because the good being exchanged in the experiment is imaginary and thus has no intrinsic value to the subjects. The monetary rewards are typically scaled to be at least comparable to the subjects' opportunity cost of time to insure that the observed behaviors are not trivial. 1

Each buyer's reward is equal to the reservation (resale) price minus the price negotiated during the experiment. Each seller's reward is equal to the price negoti­ated minus the reservation price (cost). For instance, if buyer 4 purchases a good from seller 2 at an agreed upon price of $6.00, the buyer's payoff will be $0.47 =

$6.47 - $6.00, and the seller's payoff will be $0.51 = $6.00 - $5.49. No buyer may make a trade at a price above his or her reservation price, and no seller may make a trade at a price below his or her reservation price. As the experiment proceeds, each subject records trading prices and any resulting profits on a slip of paper (Table 2). At the close of the experiment, each subject gives the slip of paper to the experimenter.

Before making a trade, buyers (sellers) must be able to observe the prices that sellers are asking (buyers are bidding). This requires that the experimenter define a mechanism, or trading institution, by which price information is exchanged. The institution most often used in competitive market experiments is the oral double auction. (The trading institution chosen can have a significant impact on the per­formance of the market. The different trading institutions and their effects on market performance are discussed in the Appendix.) Buyers and sellers are seated, and the experimenter acts as auctioneer. If a buyer wishes to bid (or a seller wishes to sell), the buyer must first be recognized by the auctioneer, and then tender a bid (ask) by orally announcing his or her name and bid (ask) price. The auctioneer will then record that information on a chalkboard or similar me­dium, where it remains in view until it is (I) accepted by someone on the other side of the market, (2) canceled by the original bidder (asker), or (3) superseded by a higher bid (or lower ask). A seller can accept a bid (or a buyer can accept an ask) only after being recognized by the auctioneer. A verbal acceptance represents a binding contract between the original bidder (asker) and the accepting party.

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PRICE

Round 2: Round 3: Round 4: Round 5: Round 6: Round 7: Round 8: Round 9: Round 10:

RESALE

Round I : $7.89 Round 2: $7.89 Round 3: $7.89 Round 4: $7.89 Round 5: $7.89 Round 6: $7.89 Round 7: $7.89 Round 8: $7.89 Round 9: $7.89 Round 10: $7.89

TABLE2 Buyer and Seller Records

Cost: $5.32

Seller number:

COST

$5.32 $5.32 $5.32 $5.32 $5.32 $5.32 $5.32 $5.32 $5.32 $5.32

Resale price $7.89

Buyer number:

PRICE

PROFIT

PRO AT

Following a verbal acceptance, each of the parties to the transaction records the trade.

The auction continues for some predetermined period of time (say, five min­utes) or until efforts to make trades have stopped. By the close of trading, all subjects have observed the same information: the number of trades that occurred, the prices at which they occurred, and the order in which they occurred.

The above procedure is then repeated for a predetermined number of rounds, or trading days. In each round, all of the sellers have one unit of the good to sell, regardless of whether they made a trade in the preceding round, and all buyers may purchase only a single unit of the good.

Note that nowhere in the instructions or during the experiment are subjects told what to do. They are not told to sell high, to buy low, or to maximize their payoffs. The experiment does not test whether economic actors are rational or whether economic actors consider more to be better. Rather, subjects are assumed to be rational and to have upward sloping utility functions. (In fact, rationality is par-

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tially imposed on the subjects by prohibiting trades beyond their reservation prices.) The experiment tests only whether a competitive market structure-no market power, costless entry and/or exit, perfect information, and a homogeneous product-results in a uniform and stable price equal to marginal cost.

Figure I and Table 3 show a standard format for reporting results from a market experiment. Figure l shows the prices at which trades were executed in each round, in the order in which those trades were executed. Table 3 compares actual outcomes to those predicted by the perfectly competitive model. The results shown are typical to those found in the literature.2 Price and quantity quickly converged to the equilibrium levels predicted by the competitive model. The mar­ket efficiency column shows that a large and increasing percentage of the poten-

$8.00

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Prediction:

I 2 3

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FIGURE 1 Results: Competitive Market

123456789 123456 1234 1234 12345 12345

Average price

$6.01-6.09

$6.19 $6.12 $6.09 $6.08 $6.07

Al>und 1 Round 2 Round 3 Round 4

TABLE3 Results: Competitive Market

SD Quantity

$.000 5

$.301 6 $.170 4 $.041 4 $.020 5 $.019 5

Round 5

Market efficiency(%)

100.0

86.9 97.0 97.0

100.0 100.0

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tial market (buyer plus seller) surplus was captured in each round. ' Price became more uniform across the rounds as shown by the diminishing standard deviation of prices. Once established, the equilibrium was stable.

WHY RUN A CLASSROOM EXPERIMENT?

The most fundamentally important of all economic principles is that voluntary trades made in competitive markets allocate society's resources efficiently. If stu­dents do not grasp this lesson early on, every lesson that follows is devalued. Unfortunately, getting students to understand why voluntary trades produce effi­cient outcomes, and, even more fundamentally, what market efficiency means, is difficult. The competitive market experiment is a remarkable tool for teaching these important lessons.

Participating in a competitive market experiment teaches students two funda­mental lessons, one during and one after the experiment. Together, these two les­sons combine to prove the invisible hand theorem that self-interested buyers and sellers unknowingly maximize social welfare. During the experiment, students observe the market converging automatically to a stable equilibrium without any direction from the instructor. Moreover, this convergence occurs even though the buyers and sellers obviously have little information-participants are armed with only self-interest, their own reservation prices, and observations of previous trades. After the experiment, students can analyze the results and discover that the price-quantity combination produced by the experiment is allocatively efficient.• This discovery requires only some simple arithmetic and is made easier because the experiment sensitizes the students to the foundations of market efficiency,

namely buyer and seller surpluses. Using market experiments in the classroom allows students to learn about

market surplus concepts even before they are introduced to them by the text or the instructor, because maximizing their own personal share of market surplus is the objective of the experiment. The incentive for each buyer (seller) is to negoti­ate a low (high) price, thus maximizing the buyer's (seller's) own surplus. It is straight-forward for students to learn that allocative efficiency is maximized in competitive equilibrium by showing that the sum of their own payoffs plus their classmates' payoffs grows to a maximum as the market clears.

Unfortunately, most principles textbooks do not reenforce this result. Allocative efficiency can be expressed in one of two ways, either by showing that price equals the social cost of producing one more unit (P = MC) or by showing that market surplus (buyer's surplus plus seller's surplus) is maximized. The P = MC story predominates in most principles textbooks, and the market surplus story is absent from some textbooks. But this is an artificial dichotomy. Definitionally, a market that produces too little is inefficient because P fails to equal to MC. At a more basic level , more fundamentally, such a market is inefficient because some­one in society is willing to pay more for an extra unit of the good than it costs someone else in society to provide that extra unit, i.e., because market surplus has not been maximized.

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The conclusion here is a strong one. Because all stories about allocative effi­ciency or inefficiency eventually rest on other stories about market surplus, why not tell students the market surplus stories right from the start? Because the incen­tives facing market actors (experimental or otherwise) are based on buyer and seller surplus, participation in the competitive market experiment makes all of these stories easier to tell. In fact, these incentives are so natural and intrinsic to economic actors that the competitive market experiment can (and probably should) be run on the very first day of class, before students have seen any theory.

THE CLASSROOM AS A LABORATORY: SOME ADJUSTMENTS

It is important for the instructor to remain faithful to the experimental design used by research economists, because this is the best way to ensure competitive market equilibria. The results of these experiments are remarkably consistent with the economic theory presented in the text and in lectures; it is desirable from the instructor's point of view for the experiment to confirm the lecture/textbook presentation whenever possible. By carefully replicating the design and lab envi­ronment of these experiments, the instructor can be confident that nothing will go wrong.

However, the objectives of the research experimentalist and the classroom ex­perimentalist are fundamentally different. The researcher clearly understands the implications of the theory being tested. Furthermore, the researcher would rather the human subjects in the experiments know little or nothing about the theory being tested. After the subjects are paid, they and the researcher need never meet again, and the subjects need never analyze the results of the experiment. The instructor uses experimental markets to teach theory, not test theory, and because of this has no interest in keeping the subjects in the dark. Although the instructor clearly understands the implications of the theory at hand, the students do not. The classroom experiment is designed to teach or reenforce theoretic principles that students are seeing for the first time or are just beginning to master.

Because of these differences in objectives, it is natural for the classroom in­structor to deviate somewhat from the techniques of the research experimentalist. First, the monetary rewards in a classroom experiment probably do not need to be as large as those in a laboratory experiment. The classroom experiment is being run as a device to teach theory, and students usually feel that an honest effort will yield some nonmonetary reward (help them learn the material better). Hence, the monetary rewards can be less than the subjects' opportunity cost of time and still provide adequate incentives for rational behavior. I currently design the supply and demand curves so the average student receives about $1.50 per experiment, although this can vary from zero to $5 .00 per student depending on the perfor­mance, the reservation price drawn, and the number of rounds performed. Al­though I have never tried it, extra-credit points might also be an adequate in­centive.5

Second, the instructor might substitute an oral negotiated-price mechanism for the oral double auction. In an oral negotiated-price market, buyers and sellers all stand in a clear floor space large enough for them to mill about. Sellers attempt

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to sell their unit by announcing (i.e., by shouting out) an ask price and hoping that some buyer will accept it. Simultaneously, buyers attempt to purchase a unit by announcing a bid price and hoping that some seller will accept it. Counterbids and counteroffers follow in the same fashion, with the trading resembling the organized confusion of a securities trading pit. When a buyer and seller arrive at a mutually agreeable price, they immediately record the trade and report the price to the experimenter, who posts the price where it can be seen by all the subjects.

Compared to the oral double auction, the negotiated-price market tends to take more rounds to converge, and the variance of prices tends to be higher.6 However, students seem to enjoy it more than the oral double auction, and the trading-pit atmosphere reenforces the competitive, proactive, self-interested message of the Invisible Hand Theorem. The absence of an auctioneer is also a pedagogical bene­fit, producing a clearer impression that laws of (human) nature drive the market to equilibrium without any direction or intervention from authorities . Because the competitive market experiment has a robust record of convergence under both trading institutions, instructors may want to use the negotiated-price market for the first experiment of the semester to establish the latter point and the more effi­cient oral double auction during any subsequent experiments.

Third, and most relevant for the purpose of this article, students acting as sub­jects for a pedagogical demonstration should not be treated identically to students acting as subjects for a research economist. Unlike the subjects in a research ex­periment, the subjects in a classroom experiment will be analyzing the results of the experiment themselves. Experimental results should be reported in a format that expedites students' analysis, not a format designed for researchers.

A PROPOSED DISPLAY FOR EXPERIMENTAL RESULTS

The format generally used to report data from market experiments is shown in Figure I and Table 3. This format creates a clear visualization of a market coming to a stable equilibrium at a uniform price, but it is designed to be read by the resear~her, not by the subjects of the experiment. While the results from a labora­tory experiment are analyzed by an economist, the results from a classroom exper­iment must be analyzed by students just learning economics. This calls for an information display that (I) recreates the experiences the students had during the experiment; (2) displays individual information for all of the students, including reservation prices and the prices for all trades that were made; (3) presents infor­mation for both sides of each trade separately; and, perhaps most important, (4) enables students to discover from the data that allocative efficiency results from competitive equilibrium.

Figures 2 through 7 and Table 4 display the results from the market experiment discussed above in a format more useful to instructors and their students.7 Note that this format displays more information than the research format. Figure 2 clearly displays the reservation prices of each participant. During the experiment, each student knows only his or her own reservation price, but complete demand and supply schedules are crucial information for the students' postexperiment analysis. Also note that a continuous demand and supply format is used rather

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" u $6.60 ~

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0

.43

7.02

2

FIGURE 2 Reservation Prices

.47

6.09 6.27

4 6

Treder Number

8 10

than the (more accurate) step function format of Figure I. This decision might seem more stylistic than substantial , but I believe that conformity with textbook and chalkboard demand and supply curves is less distracting for students.

The results from Rounds l through 5 are displayed in Figures 3 through 7. A price is indicated for each buyer ( +) and each seller (X) who made a trade during that round. (When these symbols overlap exactly, they resemble an asterisk.) The willingness to pay of the buyer (the marginal cost of the seller) is easily located by looking vertically up (down) for the reservation price. Buyers and sellers are easily paired by searching horizontally. For example, in the first round, buyer 6 made a trade with seller I at around $5 .80. Students can look at the data and easily calculate that this buyer captured only $0.04 of surplus, this seller captured $0.48 of surplus, and, because of this voluntary trade, society was better-off by $0.52.

By performing this simple arithmetic, students can calculate how much better off the market made each of their classmates in a given round. By summing up the amount of money (or extra credit) that each of their classmates will receive, students naturally calculate total market surplus, the desired measure of allocative efficiency. Furthermore, students are likely to understand the concept of market surplus and why it is a measure of market efficiency, because it was derived di­rectly from the incentives that faced students in the experiment and in other "real" buying and selling situations. This sum can then be easily compared to the poten­tial market surplus to see how well the market performed. The standard research format does not report enough information for students to do these calculations.

Figures 3 through 7 show the progress of the experiment. Students assigned high costs of production or low willingness to pay were quickly excluded from

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+

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FIGURE3 Results: Round 1

4

Trader Number Buyer X

FIGURE4 Results: Round 2

4

Treder Number

6 8 10

S eller

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+ Buyer X Seller

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FIGURE S Results: Round 3

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FIGURE6 Results: Round 4

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Round

Prediction:

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6

0 2

+

Average price($)

6.01-6.09

6.19 6.12 6.09 6.08 6.07

6.49

FIGURE7 Results: Round 5

4

Treder Number Buyer X

TABLE4 Results: Price Floor

Quantity

5

6 4 4 5 5

4

6

Seller

8 10

Market surplus

% $

100.0 6.57

86.9 5.71 97.0 6.37 97.0 6.37

100.0 6.57 100.0 6.57

59.7 3.92

the market. These figures provide students with a visual reenforcement of the efficiency of competitive markets-the market automatically excludes the ineffi­cient sellers and the buyers who value the good least.

The extramarginal students will generally complain that they were unfairly ex­cluded from making profitable trades because the reservation prices were assigned randomly. This provides an opportunity for the instructor to stress that efficiency and equity are competing goals, that the extramarginal students were worse off only in relative (not absolute) terms, and that any scheme to bring these extra­marginal traders into the market (i.e., make the market more fair) would keep the market from attaining the efficient equilibrium. A good example of the last point

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was fortuitously provided by the outcome in Round I. Even though more than the equilibrium quantity of students traded in that round, the market generated only 87 percent of its potential surplus value because some inefficient buyers and sell­ers made trades! The identity of which buyers and sellers made trades is unknown to students if the standard research format is used to report the results of the exper­iment.

This format helps emphasize some other important lessons. First, markets are social systems of potential buyers and sellers, not just a couple of lines drawn on a chalk board. Second, this social system has a natural order about it-it follows laws much like physical and biological systems do-that leads it to a stable rest­ing place.

Note two other differences between this format and the research format. The direction from which price converges to equilibrium is deemphasized. While con­vergence to the predicted equilibrium price is a major lesson, the direction of this convergence is a fine point that is better left to upper level classes. Also, the stan­dard deviation of prices is dropped from Table 3, because it is obvious from just a quick glance at Figures 3 through 7 that prices became more uniform as the market cleared.

AN EXTENSION

It is easy to modify the competitive market experiment to introduce other im­portant market principles. After Round 5 of the experiment discussed above, the

FIGURES Results: Price Floor

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instructor imposed a price floor by announcing that no trade could take place below $6.45. The results of Round 6 are shown at the bottom of Table 4 and in Figure 8. The results are a gold mine of analysis for principles students. In particu­lar, students can use the results to reveal one of the more elusive concepts in a microeconomic principles class, deadweight loss.

Round 6 produced the quantity and efficiency results predicted by theory. Fewer than the competitive number of trades were made. Only about 60 percent of the potential market surplus was captured. Students can calculate the market surplus that was captured in Round 6 ($3.92), subtract it from the market surplus fully captured in Round 5 ($6.57), and by doing so conclude that there was a 40 percent deadweight loss of market surplus due to the price floor. By looking at the graph, it is easy for students to see why the deadweight loss was so large­three of the four trades were made by inefficient sellers 6, 7, and 8, while efficient inframarginal sellers I, 2, and 3 were shut out!

Other modifications (e.g., price ceilings, exogenous shifts of the supply or de­mand curves, reducing the number of sellers in the market) can be made to pro­duce lessons on the dynamics of the marketplace and/or the effects of government intervention. As more of these modified experiments are honed for classroom use, a body of standard, classic experiments with robust results can emerge.8 In the future, it might be possible for students to reveal market theory in weekly labora­tory sessions similar to those in the natural sciences, including the preparation of lab reports.

CONCLUSION

Without a clear understanding of automatic market clearing and allocative ef­ficiency (i.e., Adam Smith's invisible hand), students will not understand the so­cial value of free and competitive markets. Nor will they be able to separate good policies from bad policies when government intervenes in failing markets. Class­room market experiments are a superior way to teach these principles. The experi­ment presented above affirms the textbook's presentation of price convergence in a more lively and indelible fashion than lectures do. Furthermore, the incentives that students face during the experiment exactly translate into the technical termi­nology students need to understand market efficiency.

Undergraduate instruction in economics is largely a passive experience. Our students can surely benefit from any opportunity that replaces lectures with active participation. Market experimentation is one way to do this. But if we are going to create markets in the classroom, we should be sure to recognize the differences between testing theory and teaching theory.

I am convinced of the efficacy of classroom market experiments. However, this conclusion is drawn from anecdotal evidence (positive remarks made by students) and subjective analysis (the improved quality of exam essays and classroom dis­cussion concerning market exclusion, deadweight losses, voluntary trades, wealth creation, and market intervention). Currently no systematic evidence exists to sup­port the hypothesis that students participating in experiments learn and retain eco­nomics better than students getting the traditional textbook-lecture treatment. In-

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structors currently using market experiments and having access to enough students for statistically significant results could contribute by running controlled

tests of the impact of classroom experiments on economic learning.

APPENDIX

A Note on Trading Institutions

Although undergraduate instruction in economics pays great attention to other elements of market structure (e.g., the size distribution of firms, the height of entry barriers, the degree of product differentiation), trading institutions are seldom if ever discussed. Prin­ciples and intermediate theory texts usually assume that the seller posts a price and the buyer takes it or leaves it. In contrast, rather than the traditional neoclassical taxonomy of monopoly/oligopoly/monopolistic competition/perfect competition, experimentalists pre­fer to group markets by trading institutions. Three types of trading institutions and their effects on market performance are discussed here.

In a posted-price market, each seller sets or posts a price that is public knowledge, and buyers respond by either purchasing or not purchasing from that seller. After some time, the seller may then reset the price higher or lower (i.e., price-searching behavior) based on the knowledge gained from the setting of the first price. Because consumers make most of their purchases in posted-price markets, it is no surprise that neoclassical market models assume posted prices.

Consumers make few purchases in auction markets and are generally not familiar with the myriad types of auction mechanisms. The most familiar auction is the English auction in which bids increase until the number of buyers decreases to equal the number of units for sale. Conversely, in a Dutch auction the ask price starts high and moves down until enough buyers materialize to equal the number of units for sale. Auctions can be single or double, depending on whether one or both sides of the market are allowed to make price announcements. Prices can be announced publicly in oral, or open outcry, auctions or sub­mitted confidentially in sealed-bid auctions. These parameters may be combined in any array of combinations. Auctions of works of art, estates, and farm equipment are generally oral English single auctions. The U.S. Treasury uses a sealed-bid single auction to issue Treasury bills. Trading at the major stock exchanges is done via an oral double auction.

Consumers make few, but usually large, purchases in negotiated-price markets. Negotiated-price markets are characterized by haggling-offer, counteroffer, counter­counteroffer- between buyer and seller. The terms of trade are private. Automobile and real estate markets use this trading institution. The trading institution described in the sec­tion titled "The Classroom as a Laboratory: Some Adjustments" conforms most closely to a private negotiated-price market, although some of the public elements of the open outcry market are also present.

Experimentalists have found that altering the trading institution can have a significant impact on the performance of the market-not unlike the effect from a change in the number of sellers or the height of entry barriers. (See Plott [ 1989] for a discussion of these results.) For instance, the oral-double-auction institution can produce the competitive price and quantity in a variety of market structures, including an otherwise monopoly market. At the other extreme, competitive markets do not always perform efficiently when sellers post prices each round. Ceteris paribus, the oral double auction performs more efficiently than the posted-price market, where prices tend to be higher and quantity tends to be lower.

An instructor wishing to introduce trading institutions into the course must perform a balancing act. On one hand, these are interesting results, perhaps reasons to rethink some of our most basic market theories. On the other hand, the instructor runs the risk of losing the student in a maze of market models and trading institutions. The students must not lose sight of the basic lessons of the principles class: competitive or near-competitive market structures result in more efficient allocations than do monopoly or tight oligopoly market

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structures, and markets come to equilibrium without the need for a social planner. Al­though it seems natural to introduce negotiated prices during the discussion of price dis­crimination or auction mechanisms when discussing secondary markets for financial assets, discussion of trading institutions is probably better reserved for upper-level theory courses.

NOTES

I. Monetary rewards for classroom experiments need not equal student 's opportunity costs. 2. The results shown are from an experiment run on February 6, 1991 , at Beloit College. The experi­

ment lasted about 50 minutes, including about 5 minutes for each round, several minutes between rounds. and time to read instructions at the onset.

3. Potential market surplus is $6.57, the difference between the total inframarginal willingness to pay ($7.89 + $7.43 + $7.02 + $6.47 + $6.09) and marginal cost ($5.32 + $5.49 + $5.62 + $5.89 + $6.0 I). The actual market surplus captured in each round is the sum of the seller surpluses and buyer surpluses captured by individuals during that round. Market efficiency in Table 3 is actual surplus divided by potential surplus.

Actual surplus in round I was only $5.71 because inframarginal seller 5 did not make a trade. but extramarginal sellers 6 and 8 and extramarginal buyer 6 did make trades. Actual surplus in round 2 and round 3 was only $6.37 because inframarginal seller 4 and inframarginal buyer 5 did not make trades. While this information is impossible to know by reading Figure I and Table 3, Figures 3 through 7 provide a clear presentation.

4. Unlike the automatic price convergence result, the market efficiency result cannot be casually ob­served. This should not be surprising-noneconorriists make market transactions throughout their lives unburdened by thoughts of market efficiency.

5. See Kormendi and Plott ( 1982) for an experiment that used grades as incentives for experimental subjects.

6. I have performed competitive market experiments over a dozen times using the negotiated-price mechanism described here. with as few as I 0 subjects and as many as 32 subjects. Price conver­gence tends to be slower and less uniform as the number of participants increases. However, even the most slowly converging experiments produced the predicted number of trades, 100 percent market surplus, and a majority of trades in the predicted price range, within seven rounds.

7. These figures were generated using the prices reported on the completed buyer and seller forms . These price data were entered into a Lotus spreadsheet written by me and then double-checked against the prices reported orally to the instructor during the experiment. Market surplus, individual profits, the distribution of prices, and all the graphs were automatically or semiautomatically gener­ated by the program. Copies of the spreadsheet template are available from the author.

8. At Beloit College, a competitive market experiment is run during the 1st week of microeconomic principles, and the data from the experiment are used to teach the lessons on supply, demand, and market clearing. A similar experiment that includes price controls or curve shifting is run during the 4th week, and students present their analysis in a written assignment. A public good experiment similar to Isaac and Walker ( 1988) is run in the 7th week, and students prepare an analysis of the free-rider problem and the prisoners ' dilemma based on the results. An experiment in which stu­dents choose output levels for individual firms in a homogeneous good industry is run during the 12th week, and the results are used to illustrate how firms ' output decisions are mutually interde­pendent. Altogether, these four experiments use about six hours of class time (including ex post discussion), but I believe that the opportunity cost is less than this because the results, the experi­ences of the students, and the written assignments facilitate the teaching of many basic concepts. Copies of the written assignments are available from the author.

REFERENCES

Chamberlin, E. H. 1948. An experimental imperfect market. Journal of Political Economy 56 (2): 95-108.

Fouraker, L. E., and S. Siegel. 1963. Bargaining behavior. New York: McGraw-Hill. Hoggatt, A. C. 1959. An experimental business game. Behavioral Science 4:192-203. Isaac, R. M. , and J. M. Walker. 1988. Group size effects in public goods provision: The voluntary

contributions mechanism. The Quarterly Journal of Economics I 03 (I): 179-99.

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Joseph, M. L. 1965. Role playing in economics. American Economic Review 55 (2): 556-65. Joseph, M. L., and P. Saunders. 1970. Playing the market game. In Recent research in economics

education, ed. K. G. Lumsden. Englewood Cliffs, N.J.: Prentice-Hall. Kormendi, R. C., and C. R. Plott. 1982. Committee deci sions under alternative procedural rules: An

experimental study applying a new nonmonetary method of preference inducement. Journal of Eco­nomic Behavior and Organization 3 (2-3): 175-95.

Plott, C. R. 1982. Industrial organization theory and experimental economics. Journal of Economic Literature 20 (4): 1484-527.

--. 1989. An updated review of industrial organization: Applications in experimental methods. In Handbook of industrial organization, ed. R. Schmalensee and R. Willig. New York: North-Holland.

Sauermann, H., and R. Selten. 1960. An experiment in oligopoly. In General systems yearbook of the Society for General Systems Research, ed. L. von Bertalanffy and A. Rapoport. Ann Arbor: Society for General Systems Research.

Smith, V. L. 1962. An experimental study of competitive market behavior. Journal of Political Econ­omy 70 (2): 111-37.

Walker, J . 1987. Experimental economics in the classroom. Journal of Economic Education 18 (Winter): 5!-57 .

Wells, D. 1991 . Laboratory experiments for undergraduate instruction in economics. Journal of Eco­nomic Education 22 (Summer): 293-300.

ANNOUNCEMENT

Eastern Economic Association Meeting A Session on Computer-Aided Instruction

Boston, MA • March 18-20, 1994

Participation is invited in a session entitled "Developments and Assess­ments in Computer-Aided Instruction in Economics." This continues the

general theme of the CAl session at the Eastern Economic Association meet­ing in Washington in March 1992. Papers should deal with how CAl is devel­oping, succeeding, or failing in all levels of economic courses.

Please send by October 10, 1993, if possible, the title and short abstract of a proposed paper and/or your willingness to serve as discussant to Thomas P. Hamer, Rowan College of New Jersey, 201 Mullica Hill Rd., Glassboro, NJ 08028-1701. Phone: (609) 863-6162. FAX: (609) 863-6553.

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