22 Experimental Economics
Investopedia
Experimental economics is used to help understand how and why markets function the way they do. These market experiments, involving real people making real choices, are a way of testing whether theoretical economic models actually describe market behavior, and provide insights into the power of markets and how participants respond to incentives—usually cash.
The field was pioneered by Vernon Smith.
Experimental economics is mainly concerned with testing in a laboratory setting with appropriate controls to remove the effects of external influences. Participants in an experimental economics study are assigned the roles of buyers and sellers and rewarded with the trading profits they earn during the experiment.
The promise of a reward acts as a natural incentive for participants to make rational decisions in their self-interest. During the experiment, researchers constantly modify rules and incentives in order to record participant behavior in changed circumstances.
Smith’s early experiments focused on theoretical equilibrium prices and how they compared to real-world equilibrium prices. He found that even though humans suffer from cognitive biases, traditional economics can still make accurate predictions about the behavior of groups of people. Groups with biased behavior and limited information still reach the equilibrium price by becoming smarter through their spontaneous interaction.
The applications of experimental economics can be seen in various policy decisions. For example, the design of carbon trading emissions schemes has benefitted from experiments conducted by economists in different regions of the world in a laboratory setting.
Investopedia: Experiemental Economics
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