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“Boundary experiments are explicitly associated with some set of laws and consist of fact-finding inquiries designed to fix the range and application of the laws, particularly with regard to extreme conditions” (Kaplan, 1964, p. 150). In the laboratory experiments reported here, we probed three distinct boundaries of the application of the law of supply and demand in markets organized as double auctions.This “law” of competitive market behavior predicts that prices will occur at a level where the quantity supplied by sellers (positively related to price) is equal to the quantity demanded by buyers (negatively related to price).Any price where quantity demanded equals quantity supplied is referred to as a competitive equilibrium (CE) price; the corresponding exchange volume is referred to as the CE quantity.The specific design parameters utilized in our experimental markets were chosen to address the following research questions.
1. In trading between b buyers and s sellers, how small must s be to invalidate the application of the law of supply and demand as a predictor of market outcomes?
2. In a market where the law of supply and demand predicts that all gains from exchange will be earned by only one side of the market (either buyers or sellers), will actual contract prices converge to the price predicted by the law of supply and demand? What minimal compensation will subjects on the other (zero profit) side of the market need to induce them to participate in trade?
3. In a market where any feasible price is also a CE price (generated by an unorthodox box-shaped supply and demand configuration where the quantity demanded equals the quantity supplied at all prices between the upper and lower bounds of…
Direct experimental tests of expected utility theory (EUT), in which subjects are asked to choose among alternative gambles or to make judgments as to their willingness-to-pay (WTP) and/or willingness-to-accept (WTA) payment for a gamble, have not been kind to EUT. As noted in the survey by Slovic and Lichtenstein (1983), the results of these interrogations are remarkably consistent in a wide variety of contexts and are robust under examinations designed to determine the effect of monetary incentives, experience, and other factors that might have accounted for the discrepancy between subject responses and the predictions of EUT. On the other hand, experimental studies of individual and market behavior based upon EUT models of market decision making have yielded results showing high consistency with the predictions of these models (see the references in Smith, 1982). Are individual revealed preferences in some market contexts more likely to be “rational” (consistent with EUT) than individual responses to choices among alternative prospects?
Several studies designed to solicit WTP and WTA responses for a variety of goods have found a wide disparity between the “buying price” and “selling price” measures of individual value (see the study and the citations therein by Knetsch and Sinden, 1984; hereafter K-S).Values of WTA obtained in this way are frequently an order of magnitude greater than values of WTP although theoretically WTP and WTA “should” differ by no more than a presumed “small” income effect. These results should not be dismissed by economists on the grounds of poor subject motivation because the experiments include some (see those in K-S) that have carefully introduced actual monetary payments and cash compensations and have not relied on hypothetical choices.
We report the results of twelve ‘double-auction’ market experiments designed to analyze the effects of asymmetric induced supply and demand configurations on the price convergence path toward a competitive equilibrium. The proposition (convergence bias) that prices tend to approach the competitive equilibrium from above (below) when consumer surplus is greater (less) than producer surplus cannot be rejected. We do, however, reject the proposition (convergence symmetry) that these convergence biases are of equal absolute magnitude. Excesses of producer over consumer surplus are found to have a more pronounced effect on the sequence of contract prices.
This paper uses experimental methods to examine two questions. Does asymmetry in the relative theoretical surplus of buyers and sellers in single market double auction (DA) exchange affect the convergence path of prices toward the competitive equilibrium (CE)? In particular, do prices tend to converge from above (below) the CE price when buyer surplus is greater (less) than seller surplus? This question is important in establishing the replicable ‘stylized facts’ that characterize market dynamics.
The second question we examine is whether agent trading behavior, as revealed in the convergence of DA markets, is symmetric with reSpect to the roles of buying and selling. Specifically, suppose we examine the convergence of DA markets in an asymmetrical supply and demand design in which, at the CE, two-thirds of the total surplus is obtained by buyers, and one-third is obtained by sellers.
In short, the argument that we cannot experiment in the behavioral sciences because the problems are too complex is no more than a blanket rationalization of our ignorance as to what experiments to perform, and how to go about performing them
(Abraham Kaplan, 1964).
Double oral auction trading on the New York Stock Exchange, and on most organized stock and commodity exchanges throughout the world, has evolved over more than two centuries. This evolution has consisted, in part, of a gradual formulation of rules governing the mechanics of “floor” trading. Our scientific curiosity as to why these institutional rules exist has motivated an interest in studying the effect of contracting rules on the convergence and efficiency properties of competitive markets. Does the “specialist book,” and the New York Stock Exchange trading post rule requiring admissible bids and offers to narrow the bid-ask range, have identifiable affects on market performance? Our working hypothesis is that the survival value of a rule is manifest in measures of improved market performance.
The 21 experiments reported in this chapter use computerized transformations of the oral double auction that have been programmed by Williams using the PLATO computer system's TUTOR language. Our interest in real-time electronic trading institutions is motivated in part by the gradual evolution of both private and government securities markets into systems based on electronic quotations and in part by the scientific value of the computer in providing closer control over the' procedures, and recording of data, in group exchange experiments.
Interest in the effect of nonbinding price controls on double auction markets stems from two primary considerations. The double auction institution converges to a competitive allocation more rapidly, and with fewer participating agents than any other institution with which it has been compared (see Smith et al.). One way to improve our understanding of this important property is to determine what conditions, if any, can interfere with or retard this convergence process. Nonbinding price controls represent a condition that may affect this convergence process. Hence, if such effects can be documented, they will provide a body of data that any future proposed model of the double auction process should be able to explain. A second reason for studying the effect of nonbinding controls on the double auction is practical: The organized commodity exchanges “… often set limits on price fluctuations during any single day. When prices at any point during a day rise above or fall below the closing prices of the preceding day by more than the amount of the limit, no further trading for that day is permitted” (Walter Labys, p. 162). Consequently, commodity trading frequently occurs at prices near the level of nonbinding price floors or ceilings.
Mark Issac and Charles Plott report the results of twelve exploratory experiments in which various price control constraints are imposed on double auction markets.
Consider a market with the following characteristics: 1) privacy, that is, each agent knows only his own valuation (or cost) conditions; 2) exchange follows the rules of the oral double auction, that is, buyers freely announce bids or accept offers and sellers freely announce offers or accept bids; 3) aggregate market supply and demand per trading period is stationary for at least two to three periods; and 4) there are at least four buyers, and as many sellers. The literature reporting the results of a large number of experimental markets with these characteristics documents what appears to be a remarkably rapid convergence to a competitive equilibrium (CE). However, any claim of double auction (DA) “convergence” to the CE can only have meaning in one of three senses:
(i) The CE is attained immediately.
(ii) After T periods of trading, some measure of the market's state, such as mean price, is nearer, relative to experimental sampling variability, to a CE than to some distinct alternative equilibrium such as a monopoly or Nash equilibrium.
(iii) After T periods of trading, this measure is nearer to a CE in DA experimental markets than in markets organized under a different institution of contract, for example, a sealed-bid auction.
This paper presents an experimental study of a computerized “posted-offer” pricing mechanism that captures many of the basic institutional features of retail exchange in the U.S. Posted-offer market performance is evaluated relative to “double-auction” market performance using two supply and demand designs. Subject experience with the trading mechanism is explicitly considered as an experimental treatment variable. The market data suggest that prices tend to be higher and efficiency lower under posted-offer pricing relative to double auction. However, the institutional effect appears to interact with other design conditions. When feasible, the predictive power of competitive, Nash, and limit-price theoretic equilibria are empirically evaluated.
The institution of posted-offer pricing is defined (Smith, 19766; Plott and Smith, 1978) as a market mechanism in which each seller “posts” a selling price at the beginning of each trading period. Once prices have been displayed to all buyers and sellers, buyers then proceed in random order to purchase the quantity each desires. Viewed as an extensive form (minorant) game, sellers move first by sending price messages, buyers respond with quantity messages disclosing how much each will buy from some seller. Each seller involved in a trade moves last by indicating when no further units will be delivered (a “stock out” occurs).
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