Topic: Market Equilibrium (Double-auction experiment)Objectives: - To let students experience how demand and supply model helps explain real-world markets, i.e. how actual prices

converge to the equilibrium values predicted by theories. - To let students explore different economic concepts involved in a simulated market situationTime: 60 minutesTarget : S4-6 students

Activity Details Teacher’s role / points to note TimeIntroduction The teacher announces that

“It is a sunny Saturday morning at the Farmers’ Apple Market. You and your classmates have come to the market to buy and sell apples. The apples sold are homogeneous. Your objective is to “make as much gain as possible.”Then distribute to each student a personal information sheet indicating whether he/she is a supplier or a demander in the market. Tell them that on the information sheet, they will also find seller cost or buyer value for a bushel of apples. Then read the instructions (see appendix 1) to students.

The teacher should make sure that students understand the instructions, or they will feel frustrated and make random decisions that muddy the results during the experiment.

10 min

Warm-up exercise(optional)

The teacher checks students’ understanding by having them answer some warm-up questions (see appendix 2).

5 min

1st round The market manager (selected by the teacher) declares Round 1 of trading The teacher should watch for and help 5 min

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to be open. As transactions take place and are reported to the market manager, he should put the sales prices, buyers’ values and sellers’ costs on a spreadsheet.

confused students, but refrain from telling students what actions to take, and intervening to affect the outcome; otherwise students will not recognize the power of markets to find the equilibrium price without intervention.The teacher should also make sure the market manager understands his job.

2nd round Ditto. In the 2nd and 3rd round, students’ roles and their values/costs remain the same, but the market information they have is different: As they have more and more information shown on the spreadsheet, there should be less price dispersion in later rounds, thus forcing the prices to converge to “equilibrium”.

5 min

3rd round Ditto.At the end of each round, the teacher asks students to record the information about the transactions of each round onto a record form (see appendix 3). Such information will help students to do analysis during the debriefing of the experiment.

5 min

Debriefing After the experiment, the teacher asks students to form groups of 2 to 4, In this session, the teacher should give 25

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and draw the demand and supply curve for the market based on buyers’ value and sellers’ cost on the debriefing handout (see appendix 4).After drawing these curves, they will be able to find the equilibrium prices and quantities as predicted by supply and demand theory. Then ask students to compare the predictions of supply and demand theory with the actual outcome (i.e. mean price and number of transactions in each round of a session), as an evaluation of the supply and demand theory.

Teachers can also use this experiment to discuss with students other economic concepts like law of demand and law of supply, consumer surplus and producer surplus, efficiency, etc. (see appendix 5)

students the chance to wrestle with the results and encourage them to attempt interpreting the results themselves, instead of providing a fast follow-up analysis himself.

min

Conclusion The teacher points out to students the aim of the experiment: to see whether supply and demand theory does a good job of predicting the outcomes of our experiments.

Normally, the prices and number of transactions will converge to the equilibrium level as predicted by the supply and demand theory.However, if the outcomes turn out otherwise, the teacher should figure out the reasons together with students (e.g. Is it because some students don’t understand the trading rules and trade at a loss? Or is it because students trade with the same person throughout the game and haven’t

5 min

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exploited all opportunities yet?)Appendix 1 Instructions1. Tell them that their objective is to make as much gain as possible. To demanders, gain means the difference between their buyer value and

the price. To suppliers, gain means the difference between the price and their seller cost. Keep in mind they should “buy low, sell high”.

2. Tell demanders and suppliers that if they don’t buy or sell any apples, their gain is zero.

3. Tell them that if they cannot find any chances of profitable trade, they are better off not trading at all than trading at a loss.

4. Tell them that suppliers can make deals only with demanders and demanders can make deals only with suppliers. When a supplier meets a demander, they can negotiate about the price in any way they wish. They don’t have to reveal their seller cost or buyer value to their bargaining partner, but they can if they really want.

5. Tell them that when a supplier and demander have agreed to trade, they should report to the market manager the trading price, buyers’ value and sellers’ cost. After this, they can leave the trading pit in the middle and return to their seat until the next round.The market manager then puts the prices, buyers’ value and sellers’ cost on a spreadsheet where everyone can see them.

6. Tell them not to be a “shy” person in order not to miss profitable trading opportunities, and not to be afraid to shout or gesture for attention, so that others know how much they are willing to pay or the price at which they are willing to sell. If students haven’t yet made a trade, they can keep an eye on the prices of previous transactions that are posted on the spreadsheet. Such information may give them some idea of what price to demand or what price to offer in their own negotiations. Also encourage them to try to find better chances of trade in different rounds of the game in order to search for the best deal, instead of sticking with the same trader all the way through, because their aim is to maximize

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gain.

Appendix 2Warm-up exercise

Suppose that a supplier with a seller cost of $20 meets a demander with a buyer value of $40.

1) If the supplier sells a bushel of apples to the demander for a price of $35, how much profit will the supplier make?And how much profit will the demander make?

How much is the total profit made by the two traders?

2) What is the highest price of apples that would permit both the seller and the buyer to make a profit of $1 or more? If this price is charged, how much is the sum of buyer’s profits plus seller’s profits?

3) What is the lowest price of apples that would permit both the seller and the buyer to make a profit of $1 or more?

If this price is charged, how much is the sum of buyer’s profits plus seller’s profits?

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Appendix 3 Record form

Table 1 Transactions in the 1st roundTransaction Price Seller cost Buyer

valueSeller’s gain Buyer’s gain

12345678910Mean price = Number of transactions = Total consumer surplus = Total producer surplus =

Table 2 Transactions in the 2nd round Transaction Price Seller cost Buyer

valueSeller’s gain Buyer’s gain

12345678910Mean price = Number of transactions = Total consumer surplus =

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Total producer surplus =

Table 3 Transactions in the 3rd round Transaction Price Seller cost Buyer

valueSeller’s gain Buyer’s gain

12345678910Mean price = Number of transactions = Total consumer surplus = Total producer surplus =

Table 4 Transactions in the 4th round Transaction Price Seller cost Buyer

valueSeller’s gain Buyer’s gain

12345678910Mean price = Number of transactions =

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Total consumer surplus = Total producer surplus =

Appendix 4 Debriefing handout (blank)Table A Sellers’ and buyers’ information

Seller’s cost Number in market Buyer’s value Number in market

$A $a

$B $b

$C $c

… …

... …

… …

Note: teachers can freely choose appropriate values for buyers’ value/sellers’ cost

Now use the information in Table A to complete the demand and supply schedule:

(For example, at the price of $A, how many sellers are willing to sell their apples?)Price Quantity supplied (units) Price Quantity demanded (units)

$A $a

$B $b

$C $c

… …

... …

… …

Use the data above to draw the demand and supply curves:

Q

P3($)$

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The demand and supply theory predicts that :

The equilibrium price is ___________and quantity transacted is ___________.

Consumer surplus is and seller surplus is

Now compare these theoretical values with actual outcomes. What do you find? Debriefing handout (an example)Table A Sellers’ and buyers’ information

Seller’s cost Number in market Buyer’s value Number in market

$18 2 $45 2

$23 2 $40 2

$28 1 $35 1

$33 1 $30 1

$38 1 $25 1

$43 1 $20 1

Now use the information in Table A to complete the demand and supply schedule:

(For example, at the price of $18, how many sellers are willing to sell their apples?)

Price Quantity supplied (units) Price Quantity demanded (units)

$18 2 $45 2

$23 4 $40 4

$28 5 $35 5

$33 6 $30 6

$38 7 $25 7

$43 8 $20 8

Note: The above data are based on the experiment done in a F.4 class of 16 students. Teachers can freely select appropriate

levels of prices and change the number of buyers and sellers according to their class size, without affecting the

significance of the experiment.

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The following data are the actual outcomes of an experiment done in a F.4 class of 16 students:

Round 1:Transaction Price Seller cost Buyer

valueSeller’s gain Buyer’s gain

1 30 23 40 7 102 30 23 45 7 153 30 18 45 12 154 20 18 40 2 205

Mean price = $27.5 Number of transactions = 4 Total consumer surplus = $60 Total producer surplus = $28

Round 2:Transaction Price Seller cost Buyer

valueSeller’s gain Buyer’s gain

1 30 28 40 2 102 31 18 45 13 14

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3 30 18 35 12 54 30 23 40 7 105 30 23 45 7 15Mean price = $30.2 Number of transactions = 5 Total consumer surplus = $54 Total producer surplus = $41

Round 3:Transaction Price Seller cost Buyer

valueSeller’s gain Buyer’s gain

1 31.5 28 45 3.5 13.52 29 23 35 6 63 30 18 40 12 104 31 18 40 13 95 31 23 45 8 14Mean price = $30.5 Number of transactions = 5 Total consumer surplus = $52.5 Total producer surplus = $42.5

Appendix 5 Questions for debriefing

Regarding the concept of demand and supply:1 . What is the relationship between the price and the total quantities buyers are

willing to buy? What economic law does it illustrate?2. What do you notice about the shape of the demand and supply curve? How are

they different from the usual ones we find in standard textbooks?3. What is the relationship between buyers’ value and the demand curve? And the

relationship between sellers’ cost and the supply curve?

Regarding the concept of equilibrium:1. According to the demand-supply diagram, what are the theoretical values of

equilibrium price and quantity?2. How close are the experimental outcomes to the theoretical values predicted by

demand-supply model in different rounds? Why?3. Are there any transactions lying way outside the equilibrium price range? What

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does this answer tell you about the nature of “equilibrium”?4. Look at the way price converges to equilibrium. What is it that makes price

converge to a certain level? Is it because of your teacher’s control, your classmates’ ideas, or other factors at work?

5. Before the game, what would you expect how the prices and number of transactions should change? Are the outcomes consistent with your expectation?

Regarding the role of information in price convergence:1. How would the market have behaved differently if the trading information had not

been posted?2. How did price information help to shape the behavior of buyers and sellers, or

your behavior?3. What is the trend of average prices throughout the game? What about the range of

prices? How are they related to the availability of market information?

Regarding consumer surplus and producer surplus:1. According to the demand-supply diagram, what are the theoretical values of

consumer surplus and producer surplus?2. How close are the experimental outcomes to the theoretical values predicted by

demand-supply model in different rounds? Why?3. “ In a perfectly competitive market, the maximizing behavior of individual

buyers and sellers ensures an efficient resource allocation.” Do you agree? Explain with reference to your observation from the experiment.

Regarding trade:1. What are the most important thing(s) that make exchange possible between

buyers and sellers?2. What determines the gains from trade for both parties?

General questions:1. Did you enjoy the game? Why or why not?2. Tell us three things that you have learned from this game/experiment.3. Tell us one thing that you do not understand about this game/experiment, and you

want to ask about.

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4. Have you found any real world markets similar to this game played? In what ways are they similar?

(For those students who have never succeeded in finding a trading partner)5. What did you feel during the game? 6. Why was it so difficult (if not impossible) to find a trading partner? 7. How could you possibly improve your chances of finding a partner?

References:1. Jeffrey Parker, 1995. Using Laboratory Experiments to Teach Introductory

Economics. Department of Economics, Reed College. 2. Bergstrom, T.C. & J. H. Miller. 2000. Experiments with Economic Principles:

Microeconomics. McGraw-Hill Companies: Singapore

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