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Additionally, economic theory depends on assumptions about the preferences of economic agents. Whether these assumptions are correct is not observable from economic activity. All that can be said is that the preference can be inferred from the choice. Experimental economists use laboratory conditions to identify preferences and to examine if those preferences actually influence economic choices the way the theory says they should. Experimental economics is an inter-disciplinary science. Not only are the economists usually well-versed in areas other than economics and mathematics, but also they work with other social scientists to determine the biological, social, and psychological reasons and causes for the choices the test subjects make. The Interdisciplinary Center for Economic Science at George Mason University, founded by 2002 Nobel Prize winner Vernon Smith , is one example of the collaboration of researchers with different areas of expertise. Testing focuses on markets and what makes them work, rules for commerce, i.e. trading, bartering, exchange, etc., and the behavior of economic agents under different market or exchange mechanisms. With these lab experiments, it is possible to estimate or predict reactions to changes in economic rules. For example, predicting corporate behavior under different environmental policies has been difficult with traditional economic theory, but experiments can help determine if a market of environmental or natural resource commodities, e.g. Pollution Allowances , Water Rights , Electricity , etc., will provide a more efficient mechanism for allocated scarce resources. An embranchment of Experimental economics is Experimental Finance , which is the application of Experimental economics in Financial Markets . The goals of Experimental Finance are to establish different market settings and environment to observe experimentally and analyze agents' behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanism and returns processes. Presently, researchers use simulation software to conduct their research. Historically most economics experiments were conducted in the Laboratory , but recently interest in economics Field Experiment s has grown. The development of experimental economics has also led to increased interest in Econometric studies of Natural Experiments . = Experimental topics = Economics experiments can be loosely classified into the following topics: Markets , Games , Decision Making , Bargaining , Auctions , Social Preferences, Learning, Matching, and Field Experiments. Market games Vernon Smith, formerly of the University Of Arizona and now at the Interdisciplinary Center For Economic Science at George Mason University conducted pioneering economics experiments on the convergence of prices and quantities to their theoretical competitive equilibrium values in experimental markets. Smith studied the behaviour of "buyers" and "sellers", who are told how much they "value" a fictitious commodity, and then are asked to competitively "bid" or "ask" on these commodities following the rules of various real world market institutions, such as the Double Auction (both sides can bid) used in many stock exchanges, as well the English auction and the Dutch auction (see Auction s). Smith found that in some forms of centralized trading, prices and quantities traded in such markets converge on the values that would be predicted by the economic theory of Perfect Competition , despite the conditions not meeting many of the assumptions of perfect competition (large numbers, perfect information). Over the years, Smith pioneered -along with other collaborators- the use of controlled laboratory experiments in economics, and established it as a legitimate tool in economics and other related fields. Charles Plott of the California Institute Of Technology collaborated with Smith in the 1970's and pioneered experiments in political science, as well as using experiments to inform economic design or engineering to inform policies. In 2002, Smith was awarded (jointly with Daniel Kahneman ) the Bank Of Sweden Prize In Economic Sciences "for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms". Social preferences The term "social preferences" refers to the concern (or lack thereof) that people have for each other's well-being, and it encompasses altruism, spitefulness, tastes for equality, and tastes for reciprocity. Experiments on social preferences generally study economic games including the Dictator Game , the Ultimatum Game , the Trust Game , the Public Goods Game , and modifications to these canonical settings. As one example of results, Ultimatum Game experiments have shown that people are generally willing to sacrifice monetary rewards when offered unequal allocations, thus behaving inconsistently with simple models of self-interest. Interestingly, the direction and size of the bias varies between cultures. (More market-oriented societies tend to have higher Inequity Aversion .) Behavioural biases in auctions Other experiments went further into the auction experiments with which Smith had begun the discipline. He showed that a naive crowd tends to pay more for any item when it sold via an (increasing price) English Auction , rather than a (declining price) Dutch Auction . One explanation of this bias is that a declining price generates a sense of "suspense", whereas an increasing price tends to give the ultimate victor in a bidding war an extra sense of satisfaction. Therefore, the social pressure not to lose may add an extra Utility to winning beyond that of the item purchased. Another explanation is the idea in a Common Value Auction that seeing other people bid for the same thing increases its probable value. (See: Classroom experiment example of Dutch auction under-valuation .) Yet another explanation is that the optimal bidding rule is more transparent in an English Auction than in a Dutch Auction. In an English Auction (for a single unit of a good) the optimal bidding strategy is to continue raising one's bid until doing so would result in a price that exceeded one's value for the unit. (Given infinitely small bidding increments this results in a unit price equal to the second highest value among the bidders.) In a Dutch Auction the optimal bidding strategy is to allow the bid price to fall to a precise fraction of one's value. The fraction is (N-1)/N, where N is the number of bidders in the auction. Naive bidders (and even many experienced bidders) are unlikely to know this bidding strategy, and may therefore allow the price to fall "too low" before purchasing. = Methodology = Guidelines Experimental economists generally adhere to the following methodological guidelines:
Critiques The above guidelines have developed in large part to address two central critiques. Specifically, economics experiments are often challenged because of concerns about their "internal validity" and "external validity", for example, that they are not applicable models for many types of economic behaviour, so the experiments simply aren't good enough to produce useful answers. Some economic theorists, especially the Austrian School , reject the entire concept of economic Empiricism , since they reach their conclusions strictly by deduction (from axioms arrived at introspectively). = Resources = See also
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