Experimental Economics

Experimental economics is a specific branch of economics that is studied through control experiments to understand how people react to specific policies and economic changes. It can be explored in a controlled laboratory or out in the field. Furthermore, it allows analysts to test theories and check on the choices people make in specific scenarios.

The economists interested in conducting such experiments invite human subjects to respond to incentives in a controlled environment. The study goes beyond the understanding of markets, trade policies, and human mindset. It enables economists to comprehend the cause-and-effect relationship and its relevance to control over variables. However, it is subject to human error and the effects of external influences.

Experimental economics is a practical approach to defining the behavior of people in real scenarios and recording their responses to understand how markets function in a certain way. These experiments are held in controlled environments but have real people making real choices. This allows researchers to explore the market dynamics and behavior. In addition, it offers insights into why specific policies or economic factors may or may not work. Participants selected for these economics-based market experiments are recorded for their response to incentives that are typically cash. 

All such economic-based experiments are conducted in laboratory settings or controlled places to eliminate the probability of external influence. The field has seen significant growth, with the establishment of dedicated journals such as the Journal of Experimental Economics, which has a notable experimental economics impact factor.  These journals give researchers a place to share their discoveries and further the field of experimental economics. Participants are assigned roles of buyers and sellers and are rewarded with trading profits earned during the experiment. The reward plays the role of an organic incentive to make rational decisions for their self-interest. The rules are constantly changed and updated to monitor participants' behavior in different scenarios. 

There are two main methods of experimental economics: the survey method and the statistical method. The survey method is used to describe the future demand of consumers and includes techniques such as the Delphi method, opinion polls, and market experiments. The statistical method calculates demand based on historical and cross-sectional data using techniques like trend projection, econometric methods, and barometric methods. The core purpose of experimental economics is to test theories, evaluate economic predictions, identify facts, and design comparisons and insights.

The history of experimental economics is vivid. It started in the US as a byproduct of massive investments, socio-political scenarios, and a fruitful culture in the 1940s and 50s. However, following the Caltech historical observations, the concept rapidly grew by developing theoretical models after the work of Vernon Smith and Charlie Plott. Key milestones in experimental economics at Caltech from the 1970s to the early 2000s include: 

• In the 1970s, market mechanisms were tested and became the basis of Caltech research. This further shaped important developments in conducting laboratory experiments.
• In the late 1970s, John Ferejohn and his co-authors highlighted the challenges of designing well-behaved mechanisms, particularly in the field of public good decision mechanisms. 
• During the same period, committee decision-making was introduced at the beginning of the 18th century. Many theoretical works in political science and first experiments were done to deal with the problems of committee decision-making. The initial experiments attempted the use of controlled laboratory experiments to test the prediction of formal theories. 
• Individual decision-making, sometimes known as preference reversal, was highly valued in 1979, as the psychology literature indicates. This suggests that individuals typically choose between the two lotteries that are offered, assigning the chosen lottery a lesser monetary value than the alternative.
• During the mid-1980s, a second series of political economy experiments was conducted by Richard McKelvey and Peter Ordeshook. This involved laboratory evaluation of elections.
• In 1992, the first Centipede Game experiment tests were conducted at Caltech by Tom Palfrey and Richard McKelvey. 
• During the 1990s, experiments on economic growth and political competition were conducted with the introduction of applied mechanism design. 
• In the transition period from the 1990s to the 2000s, Colin Camerer used beauty contest games to understand the process of people’s behavior, along with the quantal response equilibrium done again by Richard McKelvey and Peter Palfrey. 
• In the 2000s, Caltech researchers explored and learned about network formation processes among heterogeneous and homogeneous agents. 
• In the same period of the 2000s, committee deliberations were introduced, and the Caltech researchers pursued the problems of information aggregation in the collection decision-making process.

Below are two examples of experimental economics: 

Example #1

Suppose Gary is an economist and teaches economics at the town’s university. He has certain concepts and theories that he wants to test and see how people respond to these policies and change their behavior. Although he could conduct these experiments out in the field, Gary chose to perform them in a controlled environment. 

Gary selected nine students from his economics class and decided to conduct the whole experiment on the university campus. He used both statistical and survey methods to take responses and record data to analyze and evaluate. Based on the outcome, this example illustrates a simple application of experimental economics. Gary can publish a paper, deduce critical conclusions, and accomplish experiment objectives.

Example #2

In the 1960s, Vernon Smith conducted an experiment demonstrating the law of supply and demand. After almost six decades, the Caltech economists evaluated data from 2000 repetitions of these experiments, showcasing how the work of Smith and Plott has been reproduced on a large scale. 

The research was made possible through the collaboration of the economics education company MobLab, offering online experiments to students across the globe. The professors remained consistent with other classes while using MobLab tools. 

The critical differences between experimental and behavioral economics are: