Ethos Issue 6, Jul 2009
Auctions, Market Experiments
and Public Policy
A discussion with Professors Vernon L. Smith,
Stephen Rassenti and Bart Wilson
How has experimental economics
deepened our understanding of
economic theory and its implications for
public policy?
Vernon L. Smith: You can now ask
policy-type questions in laboratory
experiments which replicate markets
in the real world. You can observe very
important features of the market in
action, and confirm or reconsider your
ideas about how it will play out.
As an example of how we model
economic behaviour, we like to conduct
this double auction market experiment
at our lectures where we ask 16 people
from the audience to be eight buyers and
eight sellers in a hypothetical market.
Buyers are given values and sellers are
given opportunity costs for each unit of
the good. If the buyer is willing to pay
$12 for a unit of the good and buys it for
$9, he would make a profit of $3. Sellers
make profits when they sell above their
opportunity costs. We would reward
the buyers and sellers with cash to
motivate him. Buyers and sellers have
no knowledge of each other’s values
and opportunity costs. The equilibrium
exchange quantity of the experiment is
sixteen and each seller should have been
able to trade two of the four units that he
can produce.
With some deviations within one or
two units of the equilibrium quantity,
it is common for prices to converge by
the end of the first period. This happens
even though the participants have
never done economics before and do not
understand economics and the concept
of competitive equilibrium. It makes
no difference in the ability of people to
trade and make exchanges.
This competitive equilibrium can be
achieved even in the absence of complete
information. What really matters is
private information and knowledge.
Giving more public information on
individual circumstances may make
it worse, for example, in the case of
posted pricing.
In what ways have your market
experiments been used to illuminate
real-world problems?
Smith: Bart has also conducted
experiments of petrol markets (sponsored
by the Federal Trade Commission).
Various policymakers in the US are
pushing a ban on the refiner practice
of setting different prices for petrol to
petrol stations in different zones—a
practice also known as zone pricing.
The policymaker’s intuition suggested
that forcing refiners to charge the same
price to all stations would distribute
competition between the stations.
The objective of the experiments
was to compare the possible outcomes
between two types of market
institutions: a market where refiners
set different prices of petrol for petrol
stations in different zones, and another
market which had refiners charge the
same price for all zones.
Bart Wilson: The participants of
these experiments were refiners and
petrol station owners, and the computer
robots were the buyers. Some stations
were located near the corners of a grid
and faced little competition. Others
were clustered around the centre and
competed with each other. So the buyers
had different locations on the grid and
they went out and bought from the
different stations. It turned out that you made the consumers worse off when you
banned zone pricing. The petrol station
retailers were the ones who were going
to earn more. We found that they earned
three times as much profit with the
ban. Banning zone pricing raised prices
where consumers were getting lower
prices, because refiners raised prices to
the retailers who had higher margins,
foregoing profits on the competitive
stations with low margins. The prices
charged by retailers at the corners didn’t
fall because there was no competition at
their stations.
Smith: The experiment demonstrated
beautifully that the standard intuition
was completely wrong. It showed
policymakers what they couldn’t see
from their own perspectives. The
implication of the experiments was not
to ban zone pricing, but instead to let
the refiners do what they were currently
doing because it didn’t hurt consumers.
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