Friday, January 29, 2010

experiments

Economists study equilibrium states but often forget that it takes time to actually get there in the real world. Of course, this is crucial in experimental economics.

(That sounds mind-numbingly obvious, but I just read in Vernon Smith's autobiography that the early experiments done by ...some guy whose name I forget... were single period bargaining games that he used to show that equilibrium predictions of economic theory have no real bearing on how things work in the real world… Vernon of course replicated it with multiple periods and crashed straight in to the efficient outcome. Then again this was in the 1950's.)

But there are also different types of equilibration. If you put a system in an unstable position, it will take some time to get to the stable equilibrium even if everyone involved knows everything about the system. If you drop a ball into a bowl, it'll roll around a bit before hitting the bottom. And if you put people in a double auction where everyone knows everyone else's utility functions, it'll still take some time to get to the equilibrium price.

More often though, equilibration in economic systems isn't an inevitable fall to a stable point. It's a process of figuring out what on earth is going on. If you put people in a double auction with imperfect information, they test the waters and move around a bit, feeling out the environment. (Based on my personal experience playing these games in college, they don't ever really figure out what is going on, but balanced motivations won't allow the system to budge from the stable point anyway.) It's like dropping a ball in a bowl and before falling, it tries rolling one way or another a bit to figure out which way is down, and even when it gets there, it keeps searching around a bit for a lower point.

Not to say that humans randomly feel things out. Self-interest is more powerful than gravity. To continue abusing the ball in the bowl analogy, it's as though it gets dropped in, tries to first go to the center of the earth, realizes it can't, and settles for the bottom of the bowl.