Experiment On Competitive Market Behavior

Introduction

The purpose of this experiment is to investigate the various experimental games such as the decision making games in management and those that are made to simulate the so called oligopolistic phenomena in the market. The experiment aims at reporting various experimental games which are made to study the hypothesis in the neoclassical market theory of competition. The experiments are designed in a manner to simulate a certain modest scale. The main intentions of the experiments are to act as simulations of specific features in the organized markets. The conditions of the experiment’s demand and supply in the markets are closely modeled on the curves of demand and supply which are generated as a result of limit price orders that are in the commodity and stock market brokers (Fehr & Gächter, 2000).

The paper aims at studying the neo classical competitive market theory on the simple demand and supply curves which are studied in economics. The purpose of the experiment is to study the way demand and supply configurations are likely to cause equilibrium and also the way equilibrium is caused by dynamics.

Theoretical Predictions

According to Walrasian hypothesis, convergence is supposed to be faster when there is large demand or supply. This means convergence is supposed to be faster in the case of test 2 as compared to test 3.

On the other hand, excess rent hypothesis focus on profits that are unrealizable in prices such that, the higher the price, the faster it should adjust. This hypothesis identifies the stochastic equation that represents well the tendencies of price convergence. The hypothesis states that,

∆pt = Pt+1 – Pt =f[x1(pt), (1)

X2(p2) . . ].1 + er

Where x1 and x2 are characteristics of demand and supply curves as well as the individual’s bargaining characteristic in the test group. A random variable in this case represented by er has a zero mean. In an experimental test applying the Walsian hypothesis, x1(p1) could be the demand in excess prevailing. This is at p1 and f=0 when the x1 is equal to 0(Fehr & Gächter, 2000).

Experimental set up

The set up involves the groups of subject being divided into two and at random, where there is one group for the sellers and another for buyers. Each of the participating buyers is provided with a card with a number which is only known to the buyer. The number represents the highest price he would pay for a unit of a commodity. The buyers are told not to buy a commodity at a higher price than one indicated on the card (Smith, 1962). The buyers could be willing to give the same amount as indicated in the card or much less for a commodity. The buyer is also instructed to think of making some profit similar to the difference between contact price and the price on the card.

Each seller obtains a card with a number only known to him. The number represents the lowest price he can accept to sell a unit of the product or commodity. The sellers have instructions to accept selling at the minimum price other than not selling. However, they should make pure profit that is determined through deducting contact price and reservation price. In every hypothetical price, the quantity corresponding represents the amount which can be sold using this price. Supply curve will then define the likely supply quantities in every hypothetical price.

Every buyer and seller is given a chance to have a contract to exchange a commodity in any one market period. The rule is meant to simplify the process.

The experiments took duration of 5-10 minutes depending on the number of individuals participating(Smith, 1962).

Analysis of the experiment.

It was observed that the quantity and equilibrium price are almost the same for the demand and supply curves in two tests. i.e, 2, 3.

(Fehr & Gächter, 2000)

The only difference is that the demand and supply schedules in test 2 are flat as compared to the ones in test 3 which are steeply inclined. Walrasian hypothesis states that the increase rate in the exchange price becomes an increasing function in excess demand of the stated price. It would have been expected that the test 2 market could converge rapidly as compared to test 3(Smith, 1962).

However, the results showed a less erratic and more rapid tendency on the equilibrium. The results are in line with several other hypotheses such as the excess rent. In test 4, the supply curve was elastic as the sellers had cards with $3.10. The sellers had similar lower bounds on their acceptance set reservation price. The sellers did not harbor divergence attitudes even though they showed marked variation on the propensities of bargaining (Smith, 1962). The results showed that the market wasn’t slow in the process of converging but does so in a stable price that is $0.20 higher than the equilibrium predicted. Test 7 was to give additional information for contradicting or supporting the hypothesis indicated. It was evident that the buyer’s rent was smaller than that of the seller. This means the convergence on the side of equilibrium is much slow. For instance for three periods of trading, the exchange prices were $3.32, 3.33 and 3.34 respectively (Roth & Kagel, 1995).

Experiment 5 was meant to study effect of market change of behavior in the demand and supply conditions. The experiment was performed on a mature group and normal profits were obtained (Fehr & Gächter, 2000). This means, there were small returns even when the goods were sold at lower supply prices or even bought at higher demand prices. The aim of test 6 was to determine the way marked imbalances on the intramarginal buyers and sellers affected the market equilibrium. The demand curve was able to fall towards right in steps of one unit while supply curve was elastic at $4. The hypothesis held that the large rent of $6.75 that the marginal seller enjoyed with large rents of intramarginal sellers could prevent the establishment of theoretical equilibrium.

Test 8 was done to test the effects due to changes in the organization of market and prices in the market. In the first instance, only sellers could enunciate offers. Buyers had a passive role and could either reject or accept offers and couldn’t make bids. This was meant to simulate ordinary market. The results were that the quotations of price were above equilibrium. In tests 9 and 10, the sellers and buyers were allowed to have 2 contracts in each period and the market experience was gained two times (Smith, 1962).

(Fehr & Gächter, 2000)

Each of the traders is able to experiment more in every market.

Conclusion.

Experimental literature however describes that poor performances may be improved with very much intense subject training on instructions. Smith focused on interactions among agents in certain market environments and looked at methodological issues that develop practical methods in experimenting and coming up with what constitutes better experiments. This calls for further research in developing more experimental methodologies and coming up with more ideas in new areas of research. It is not possible to assert a broad generalization basing on the experiments discussed. However, it is important to note the following points related to the experiment.

One, even if the numbers are not many, strong tendencies for demand and supply competitive equilibrium are attained especially when one is in a position to prohibit collusion and maintain publicity of transactions, offers and bids. Two, the changes in demand and supply conditions lead to the change in transaction volume in every period or general level of the contract prices. Three, some evidence in predicting static equilibrium especially on competitive market should have knowledge in the shapes of demand and supply schedules. This is evident when the supply curve is elastic and empirical equilibrium is much higher than theoretical equilibrium. The markets with institutional organizations is made in a manner that only sellers can make quotations of prices. This could lead to weak equilibrium as compared to when the sellers and buyers make quotations of prices (Smith, 1962).

Finally, the Walrasian hypothesis which is in relationship with market mechanism adjustment is not confirmed. The most adequate hypothesis is excess rent that relates “ speed” in adjustment of contract price to buyer algebraic excess and seller rent and in this case “virtual” rent instead of the seller rent and equilibrium buyer.

References

Fehr, E., & Gächter, S. (2000). Fairness and retaliation: The economics of reciprocity. The journal of economic perspectives, 14(3), 159-181.

Roth, A. E., & Kagel, J. H. (1995). The handbook of experimental economics (Vol. 1). Princeton: Princeton university press.

Smith, V. L. (1962). An experimental study of competitive market behavior. The Journal of Political Economy, 70(2), 111-137.