Experimental Economics: An Overview

Experimental economics is a relatively new branch of economics. By challenging the axioms of human behavior used  in traditional analysis, experimental economics has opened the way for a new strain of research, featuring a more sophisticated human model, where bounded rationality, various psychological biases, social interaction and reciprocity are taken into account. By broadening the scope for research, experimental economics is helping to push the frontiers of economic knowledge.

Experimental economics is now an established field of research. According to calculations by Armin Falk and James Heckman, the proportion of experimental papers in top economics journals has risen from almost nothing before 1965 to about 4% in the period 2000-2008. The specialized journal, Experimental Economics, was established in 1998. In 2002, Professor Vernon L. Smith received the Nobel Prize in economics "for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms”. In 2009, Professor Elinor Ostrom received the Nobel Prize in economics for her outstanding contribution to analyzing complex economic systems; one important dimension of her work was experimental analysis of common-pool resource dilemmas.

Laboratory tests provide insight into human behavior that goes beyond traditional field data studies (which have their own, unique strengths). As Daniel Friedman and Alessandra Cassar have observed, “in an experiment, you actively engage the world and create a learning opportunity that would not otherwise exist”. The basic principle of experimental research is controlled variation. Individuals are asked to make decisions, researchers observe them, a treatment is subsequently applied, and the observer tries to detect a change in the way the same people then make decisions.

Since many experiments can be described as simple games, there is a natural relationship between game theory and experimental economics. The main advantage of experimental research comes from the fact that the person conducting the experiment can control the game: he controls the payoffs, the rules of the game, the circulation of information, the level of interaction, whether the play is repeated or not, and so on.

In experimental economics, the subjects have all the information about the game they are playing: there is no attempt to mislead them about the true purpose of their participation. From this perspective, ethical challenges are rather incidental in this particular field. Furthermore, the subjects of economic experiments are paid, most often in cash, a factor that often guarantees that they take the task at hand seriously. Naturally, there is a difference between earning 2000 euros and 20 cents, a discrepancy that leads certain critics to argue that playing laboratory games tells us nothing about “real life” decision-making. Yet experimental economics does not aim to replicate “real life” – but to understand why, in a given setting, when introducing a controlled change, the outcome of the game play of the same people does changes.

There is arguably no economic and management problem that cannot be transposed within an experimental framework. Nevertheless, experimental economics research in a business school context raises several relevant topics, including the role of trust and trust building in the market economy, the emergence of various market equilibria in non-cooperative and cooperative settings, auction pricing, altruism and the production of public goods, corporate social responsibility and objectives for contemporary companies and organizations, the testing of behavioral axioms in finance and economics, incentive pay and employees’ compensation, and individual and group decision making, amongst many others.

References

Daniel Friedman and Alessandra Cassar, 2004, Economics Lab. An Intensive Course in Experimental Economics, Routledge.

Armin Falk, James J. Heckman, 2009, Lab experiments are a major source of knowledge in the social sciences, IZA Discussion Paper, Nr. 4540