Donhatai Harris [email protected] Cambridge Experimental &Behavioural Research Group (CEBEG)

An Introduction to Experimental Economics: How to gain an insight into human's behaviour and decisions

Donhatai [email protected] Experimental &Behavioural Research Group (CEBEG)Faculty of EconomicsUniversity of Cambridge, UK

Outline of Today’s Lecture

I. Why Experiment?II. What is experimental economics?III. How to conduct an experiment: Key Principles

of experimental economicsIV. Previous experiment work in Thailand (Harris

et al., 2008)V. Key contributions of Experimental Economics

to Economics Discipline and Future Challenges.

Donhatai Harris

I. Why experiment?

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Economics has been regarded as a non-experimental science, where researchers – as in astronomy or meteorology – have had to rely exclusively on field data, that is, direct observations of the real world.

The lack of experimental data meant that when an economic proposition appeared not to be captured by the data or the outcome was not as predicted by the theory, the quality of the data was more likely to be questioned than the relevance or quality of the theoryBut the theory may not always be correct, particularly in predicting human behaviour!

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I. Why experiment?

Testing theories Establish empirical regularities as a basis for

new theories Testing institutions Studying preferences and decision-making

Goods (public goods), risk, fairness, time preference

Replication of previous work Teaching economics

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Objectives of Economic Experiments

II. What is Experimental Economics?

II. What is experimental economics?

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Experimental economics is an empirical tool that enables economists to understand the extent to which an individual’s decision and behaviour are affected by various (testable) factors in a controlled environment.


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To establish whether an independent variable influences the dependent variable (outcome) “treatment effect” need to establish counter-factual.

Controlled experiments represent the most convincing method of creating the counterfactual, since they directly construct a control group via randomization.


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An example: Theory: Sub-game perfect equilibrium (Selten,

1965)Experiment: A simple bargaining game with 2

players (Guth, Schmittberger and Schwarze, 1982):

Player 1 makes a proposal for how a sum of money is to be split between players 1 and 2.

Player 2 then either accepts, implementing the proposal, or rejects, in which case the interaction ends with zero payoffs for each.

What is SPE? & What do you think happens in the experiment?Donhatai Harris

I. Why experiment?

The result show… A marked contrast between theory and

experiment But why should we be interested in this result? Is the experimental environment sufficiently close

to the situation of interest to be informative?

Rather..we should ask

How special is the laboratory environment generating the experimental results?

Is it just one result? Can it be replicated? Is it robust?


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The body of experimental evidence suggests that our simplest theories of bargaining leave some aspects of behaviour unexplained.

The importance of reciprocity and fairness concerns Theory of Inequity Aversion Preference (Fehr and Schmidt, “A Theory of Fairness, Competition, and Cooperation”, Quarterly Journal of Economic, 1999)

“In addition to selfish individuals, there are people who dislike outcomes that are perceived as inequitable.”


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The second term in (1)or (2) measures the utility loss from disadvantageous inequality, while the third term measures the loss from advantageous inequality.

The model is centred around a utility function that involves one's own payoff and the payoff of one's opponent, and that exhibits some aversion to payoff inequality.

Typology of economic experiments (Harrison & List, Journal of Economic Literature 2004) Conventional lab experiment

▫ Standard subject pool of students▫ Abstract framing▫ Imposed set of rules

Artefactual field experiment▫ Like a conventional lab experiment but with a non-

standard (i.e., non-student) subject pool Framed field experiment

▫ same as an artefactual field experiment, but with field context in either the commodity, task, or information set that the subjects can use

Natural Field Experiment▫ same as a framed field experiment but where the

environment is one where the subjects naturally undertake these tasks and where the subjects do not know that they are in an experiment.


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Sources of empirical dataHappenstance Experimental

Field •GDP •Inflation•Unemployment rate

(field data from economic outcomes)

• Policy experiments• Experiments as part of

representative surveys• Experiments conducted outside

the lab

Lab Discovery of Penicillin Laboratory experiment

In a controlled environment

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III. How to conduct a laboratory experiment

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Key principles (Smith, 1982; 1994) In laboratory experiment, a microeconomic system is

created which reflects a complete and self-contained economy.

Two important components:

(i) Environment: ▫ Economic agents with Preferences, technology, and

initial endowments▫ Controlled by using monetary rewards

(ii) Institution (rules of the game):▫ Possible actions ▫ Sequence of actions▫ Information conditions▫ Framing (language, story)

III. How to conduct an experiment?

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The Essence of Economic Experiments Experimenter knows what is exogenous and

endogenous.

Experimenter controls information conditions.

Experimenter knows the theoretical equilibrium and adjustment can be studied.

Evidence is replicable.


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Control To control a variable means fixing and maintaining

it at some constant level, or alternatively, set it at different levels across different experiments or at different points of time in the same experiments.

The subjects are likely to have prior characteristics and preferences which are difficult to observe. Therefore, control over preferences is the most significant element of laboratory experiments.

In many experiments the experimenter wants to control subjects’ preferences. How can this be achieved?


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Theory of Induced Valuation Subjects’ “homegrown” preferences must be

“neutralized” and the experimenter “induces” new preferences. Subjects’ actions should be driven by the induced preferences.

This is done by inducing or controlling valuations by making the objects of trade = valueless tokens, which can be exchanged into real money at the end of the experiment.


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Reward Medium: Money m = (m0 + m) where m0 represents a subject’s “outside” money, m denotes money earnings in the experiment.

Subject’s unobservable preference: V(m0 + m, z) where z represents all other motives e.g. boredom

In order to minimise the effects of m0 and z, whilst maximise the effect of m, laboratory experiments are required to satisfy 5 important conditions which are known as “precepts”


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Precepts Precept 1: Nonsatiation and Monotonicity

Costless choice between two alternatives, identical (i.e. equivalent) except that the first yields more of a reward medium than the second, the first will always be chosen (i.e. preferred) over the second, by an autonomous individual

Precept 2: Saliencysuch rewards must be associated indirectly with the message actions (or decisions) of experimental subjects and that they understand this relation


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Precept 3: Dominance The reward structure dominates any subjective costs (or values) associated with participation in the activities of an experiment.

Precept 4: PrivacyEach subject in an experiment is given information only on his/her own payoff alternatives.

Precept 5: ParallelismThe behaviour of individuals and the performance of institutions that have been tested in laboratory microeconomies also apply to non-laboratory microeconomies where similar cateris paribus conditions hold


Experimental Design and Procedure1) Phases of Economic Experiment

preliminary phase (experimental design) pilot experiment exploratory experiment (actual

experiment) follow-up experiments


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2) Human Subjects

Student: convenient, low opportunity cost. Non-student: increases parallelism, but

high opportunity cost, risk of unknown confounds.

(Minimum of 30 independent observations and Always invite 20% more than you need)

Recruiting the subjects is key! Manual recruitment computer-assisted recruitment


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Recruiting the subjects

Centre for Research in Microeconomics [CReMic]


Experiment session will appear here

3) Experimental Design

Focus variable(s) Treatment Other variables (Nuisances) controlled

between-subject vs. within-subject designs

‘session’ = a unit of experiment. An experiment can have many sessions.


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4) Instructions, Framing, and Anonymity

Instructions tells subjects what they are asked to do in the experiment

Framing: The way in which the instruction is worded can be distinguished into ‘neutral’ or ‘loaded’ frames.

Anonymity


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5) Conducting an Experiment

A step-by-step procedure Set up the lab: What Does a Lab Experiment

Look Like?


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Computerised experiment

Pen & paper experiment

Registration

• Print a list of subjects for that session for registration


Start the experiment• Welcome statement• Prepare lab IDs for randomisation• If more people turn up than needed: (1) Ask for volunteer to leave and get the show-up fee (2) If not volunteer, do a random draw (prepare lab IDs

for randomisation with some blank ones)

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During the experiment Each participant is asked to pick a computer lab

ID which corresponds to their seats in the lab. The participants then enter the lab one-by-one.

The Silent rule: once entered the lab, the participants are not allowed to communicate to each other (in order to ensure that they make the decision individually and privately) and are seated behind a partition.

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http://www.iew.uzh.ch/ztree/index.php

Z-tree

Z-leaf Z-leaf Z-leaf Z-leaf Z-leaf

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http://www.iew.uzh.ch/ztree/index.php

z-Tree: basic concepts Subjects enter input into screens. Output

(parameters, results etc.) also shown on screens.

Subjects navigate through different screens in z-Leaf as they move through “stages” in z-Tree.

Experimenter controls the experiment through z-Tree and can monitor what the subjects are doing.

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Post-experimental questionnaire

Negative Payments or Bankruptcy

Data Recording and Analysis▫ qualitative or descriptive phase▫ quantitative analysis of treatment effect i.e. ‘does

treatment X affect outcome Y?’


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Internal and external validity

Internal validity: Do the data permit causal inferences? Internal validity is a matter of proper experimental controls, experimental design, and data analysis.

External validity: Can we generalize our inferences from the laboratory to the field?


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IV. Experimental Study of Favouritism: Thailand vs. UK

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The Impact of Social Norms on Favouritism Behaviour

Donna Harris University of [email protected]

With Benedikt Herrmann (Nottingham) and Andreas Kontoleon (Cambridge)

I. Definition & Research Question Definition: Favouritism = Preferential treatment giving to

one person or group at the expense of another.

Broad research questions:

1) If favouritism creates Pareto inferior outcome, why is it still observed in many countries around the world?

2) Why do we observe varying degrees of favouritism across countries?

What is the role of social norms in determining the level of favouritism within a given society?

II. Related Literature Literature on Favouritism: Previous studies have not

explained ‘why’ different levels of favouritism are observed in different countries– most have focused on the ‘effects’ of favouritism.

Social Norms & Enforcement Mechanisms: Most previous studies have only focused on one type of norm, such as the norm of cooperation, or one social group and the enforcement of social norm within that group, except for Bernhard et al. (2006); Goette et al. (2006); Gaechter and Herrmann, 2007; Herrmann et al. (2008).

Specific Research Questions

What is the social norm regarding favouritism?

Can the prevalence of a particular norm regarding favouritism lead to different levels of favouritism across countries?

The norm which is prevalent strongly enforced by different social groups within a society.

Can different social groups follow different social norms?

In-group bias vs. egalitarianism vs. Out-group Bias Norms

IV. Experimental DesignAllocation Game (Favour game)

7 players, 1 decision-maker, 3 in-group members & 3 out-group members.

T0: No punishment (baseline)T1: Only the ‘in-group’ members are allowed to punish (cost:

punish = 1: 5)T2: Only the ‘out-group’ members are allowed to punish (cost:

punish=1:5)T3: Only an independent ‘third-party’ is allowed to punish (cost:

punish=1:3)

The Choice set: Control for allocation space

In-group Favouritism

Anti-social preference

Generalised Inequity Aversion

Out-group Favouritism

Each member of YOUR group

Each member of the OTHER group

Result 1: In-Group Punishment

The threat of in-group punishment increases favouritism in Thailand but does not have the same effect in the UK.

Result 2: In-group Punishment Behaviour

In Thailand, on average the other in-group members punished the decision-makers the most when they choose option B and D, while in the UK options C and D get punished the most.

75% chose not to punish


Result 3: Out-group Punishment

The threat of out-group punishment reduces favouritism and shifts the allocation decisions towards equitable outcome in the UK, but not in Thailand.

Result 4: Out-group Punishment Behaviour

In Thailand, on average the out-group members punished the decision-makers the most when they chose option B , whilst in the UK options A and B were punished the hardest.



Result 5: Third-Party Punishment

The threat of 3rd party punishment increases favouritism in Thailand but does not have any impact on favouritism in the UK.

Result 6: Third-Party Punishment Behaviour

In Thailand, uninvolved third-party punished decision-makers who chose option A the hardest, whilst in the UK only 1 third-party punished - option B.


VI. Concluding Remarks(1) What is the social norm regarding favouritism?

There appears to be a strong ‘in-group bias norm’ in Thailand (collectivist society) which is expected to be enforced within the group and by the third-party.

Within the UK, it is not clear what the social norm is within the context of favouritism:

There is already a high level of in-group favouritism without expectation of punishment, but ‘in-group bias norm’ does not appear to be strongly enforced within the group. People appear to be willing to punish favouritism if they are directly affected by it (out-group), but not if they are not affected (third-party).

VI. Concluding Remarks (cont.)(2) Can the prevalence of a particular norm regarding

favouritism lead to different levels of favouritism across countries?

Possible. Within Thailand, strong in-group bias norm means that the out-group are passive, even though they are directly affected, whilst the third-party is also expected to enforce this norm No conflicting norm favouritism is encouraged high level of favouritism.

Within the UK, high level of favouritism is already observed even without the threat of punishment from the in-group norm inherence without enforcement? But out-group provides a counter-mechanism conflicting norm lower level of favouritism.

(3) Can different social groups follow different social norms? Seems to be the case for the UK, but not Thailand.

V. Contributions of Experimental Economics and Future

Challenges

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Summary of Main contributions of experiments to economics

The analysis of markets under perfect or imperfect information e.g. auction, interaction between employer & employee in the labour market.

The understanding of individual decision-making (loss aversion, endowment effect, ambiguity aversion, law of small numbers, preference reversal, …)

The study of social interactions and preferences (altruistic, punishment, trust, fairness, inequality aversion, …)

V. What has been done & What’s Next?

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Some of the important notions in economics have been challenged by experimental research, in particular:

preferences are not always stable and consistent;

the agents do not have perfect knowledge of their preferences;

they do not always use all the available information to make decisions.

Self-interest is not the only preference that drives the individuals’ decisions.

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Contribution to institutional design/ public policy questions.

Analysis of funding modes of collective goods or political campaigns.

Experiments can help in analyzing the agents’ preferences when markets do not exist.

It also offers academics an innovative teaching tool! (see Charles Holt, 2006, “Markets, Games, and Strategic Behaviour).

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Future directions Interaction with psychology & Development of

“behavioural game theory”

Interaction with anthropology & cross-cultural experiment

Interaction with political scientists: voting behaviour & decision-making in committee.

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Future direction Development of “Neuroeconomics” (brain

imaging, EEG, PET and fMRI) and “physionomics” (skin conductance measures, heart rate, measures of hormones, study of pupil dilation).

Opening the “black box of brain activity” (Camerer, Loewenstein, and Prelec, 2005)

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Future direction The reinforcement of the realism of economic

experiments and the diversification of protocols improving “external validity”.

Field Experiment: Levine and Plott (1978) “A Model of Agenda Influence on Committee Decisions”, AER/ Harrison and List (2004), “Field Experiments”. Journal of Economic Literature.

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Major theoretical and methodological challenges What is the best way to update the

standard theories?- Should one incorporate social preferences, and

non-monetary sources of motivation in the utility function and where should one put the limit in the manipulation of this function?

- When do market forces dominate and when do social preferences dominate?

- When do selfish people contaminate the socially-oriented subjects? Donhatai Harris


Major theoretical and methodological challenges How to determine what should be the status of

agents’ heterogeneity in preferences or abilities ?

A challenge is that a lab experiment must reproduce a theoretical model but it must be at the same time able to mimic the field context reliably.

How can one interpret the differences revealed by the comparison of field and lab experiments? Donhatai Harris


In conclusion… Experimental economics constitutes a powerful

method to develop knowledge in economics.

It helps in identifying empirical regularities and so doing it inspires new research questions.

It contributes to the renewal of economic theory by incorporating emotions, affect and cognition in the analysis of behaviour.

Replication is crucial for certifying the robustness of scientific results from experiments.

Donhatai Harris

Donhatai [email protected]

Cambridge Behavioural and Experimental Economics Group (CEBG)

(www.econ.cam.ac.uk/cebeg)

Thank you for your attention

Questions & Comments are welcome

Donhatai Harris [email protected] Cambridge Experimental &Behavioural Research Group (CEBEG)

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