1 Bringing the Dismal Science to Life: Lessons from Economic Experiments 2007 Capital Campus California Retreat January 19-20, 2007

1

Bringing the Dismal Science to Life: Lessons from Economic

Experiments

2007 Capital Campus California Retreat

January 19-20, 2007

2

Economists employ controlled experiments in building and testing theory.

In an experiment, one tests for a specific response to a specific stimulus.

In a simulation, one observes a suite of (sometimes unpredicted) auto-generated stimuli and responses.

Economic simulations are useful for gaining intuitions into complex processes.

3

The purpose of this simulation is to create a competitive segmented market and to observe the market as it achieves equilibrium.

In this simulation, you will experience real market forces. The same human traits and behaviors that govern real markets exist in the simulation.

What are artificial are your surroundings. The market forces are real.

4

The Simulation

The purpose is to simulate the manufacture of a product in a competitive environment.

• 1/3 of the players are manufacturers. Manufacturers use materials L and H to produce their product.

• 1/3 of the players sell material L to the manufacturers.

• 1/3 of the players sell material H to the manufacturers.

5

The Players and the Objects

L Sellers

= 1 unit of material L

H Sellers

= 1 unit of material H

Manufacturers

= 1 dollar = 50 cents (each)

6

Goals

L Sellers Sell your supply of L for as much as possible.

Goal: End with as much money as you can.

H Sellers Sell your supply of H for as much as possible.

Goal: End with as much money as you can.

Manufacturers Buy L and H. Use them to manufacture.

Everything you manufacture is automatically sold for $1 each.

Goal: Maximize your profit.

7

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 250 0 35 46 54 61 67 72 76 80 84 88 91 95 98 101 103 106 109 111 114 116 118 121 123 125 127

1 0 39 51 60 68 74 80 85 89 94 98 101 105 108 112 115 118 121 123 126 129 131 134 136 138 141

2 0 41 54 64 72 79 85 90 95 99 104 108 112 115 119 122 125 128 131 134 137 139 142 145 147 150

3 0 43 57 67 75 82 88 94 99 104 108 112 116 120 124 127 131 134 137 140 143 146 148 151 154 156

4 0 45 59 69 78 85 91 97 102 107 112 116 120 124 128 132 135 138 142 145 148 151 153 156 159 161

5 0 46 60 71 80 87 94 100 105 110 115 119 124 128 132 135 139 142 146 149 152 155 158 161 163 166

6 0 47 62 73 82 89 96 102 108 113 118 122 127 131 135 138 142 146 149 152 155 158 161 164 167 170

7 0 48 63 74 83 91 98 104 110 115 120 125 129 133 137 141 145 148 152 155 158 162 165 168 170 173

8 0 49 64 76 85 93 100 106 112 117 122 127 131 136 140 144 148 151 155 158 161 164 168 171 173 176

9 0 49 65 77 86 94 101 108 114 119 124 129 134 138 142 146 150 154 157 161 164 167 170 173 176 179

10 0 50 66 78 87 95 103 109 115 121 126 131 136 140 144 148 152 156 159 163 166 169 173 176 179 182

11 0 51 67 79 88 97 104 111 117 122 128 133 137 142 146 150 154 158 161 165 168 172 175 178 181 184

12 0 51 68 80 90 98 105 112 118 124 129 134 139 143 148 152 156 160 163 167 170 174 177 180 183 186

13 0 52 69 81 91 99 106 113 119 125 131 136 140 145 149 154 158 161 165 169 172 176 179 182 185 188

14 0 53 69 82 91 100 108 114 121 127 132 137 142 147 151 155 159 163 167 171 174 178 181 184 187 190

15 0 53 70 82 92 101 109 116 122 128 133 138 143 148 152 157 161 165 169 172 176 179 183 186 189 192

16 0 54 71 83 93 102 110 117 123 129 134 140 145 149 154 158 162 166 170 174 177 181 184 188 191 194

17 0 54 71 84 94 103 111 118 124 130 136 141 146 151 155 160 164 168 172 175 179 182 186 189 193 196

18 0 54 72 84 95 104 111 119 125 131 137 142 147 152 156 161 165 169 173 177 180 184 187 191 194 197

19 0 55 72 85 96 104 112 119 126 132 138 143 148 153 158 162 166 170 174 178 182 185 189 192 196 199

20 0 55 73 86 96 105 113 120 127 133 139 144 149 154 159 163 168 172 176 179 183 187 190 194 197 200

Units of H PurchasedU

nit

s of L

Purc

hase

d

8

Example

Player L1 Sells 6 to Player 7 for $5 each.

Player H4 Sells 8 to Player 7 for $5 each.

Results

Player L1 ends the simulation with (6)($5) = $30.

Player H4 ends the simulation with (8)($5) = $40.

9

Example

Player 7 manufactures 92 units of product that isautomatically sold for $1 per unit.

Result

Player 7 ends with (92)($1) - $30 - $40 = $22 profit.

0 1 2 3 4 5 6 7 8 9 100 0 30 40 47 52 57 61 65 69 72 75

1 0 33 44 52 58 63 68 72 76 80 84

2 0 35 47 55 62 67 72 77 81 85 89

3 0 37 49 57 64 70 76 80 85 89 93

4 0 38 50 59 66 73 78 83 88 92 96

5 0 39 52 61 68 75 80 85 90 95 99

6 0 40 53 62 70 76 82 87 92 97 101

7 0 41 54 64 71 78 84 89 94 99 103

8 0 42 55 65 73 79 85 91 96 100 105

9 0 42 56 66 74 81 87 92 97 102 106

10 0 43 57 67 75 82 88 94 99 104 108

11 0 44 57 68 76 83 89 95 100 105 109

12 0 44 58 68 77 84 90 96 101 106 111

Units of H Purchased

92

10

Trading Rules

L Sellers and H Sellers must remain in their seats.

L Sellers and H Sellers display cards indicating their ask prices.

Manufacturers may only purchase 1 unit of L or H at a time.

Purchase the unit, take it to your seat, go back and purchase another unit, take it to your seat, etc.

11

Low-Skilled Labor Market

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

0 2 4 6 8 10 12 14 16

Low-Skilled Workers

Lo

w-S

kill

ed L

abo

r W

age

Rat

e

Demand SupplyThese workers are better off by this much.

These workers are worse off by this much.

12

Wage Rate

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

Round 1 Round 2

Low Skilled Labor High Skilled Labor

Imposing a $3 minimum wage

1. Raised the wage rate for both categories of labor;

2. Decreased the wage difference between the categories of labor.

13

Unemployment Rate

0%

10%

20%

30%

40%

50%

60%

Round 1 Round 2

Low Skilled Labor High Skilled Labor


1. Created unemployment among the low skilled labor;

2. Had no significant effect on unemployment among the high skilled labor.

14

Profit

$0

$200

$400

$600

$800

$1,000

$1,200

Round 1 Round 2


1. Reduced corporate profits;

15

Production

640

650

660

670

680

690

700

710

Round 1 Round 2


2. Reduced production.

16

How does the simulation compare to reality?

17

Source: Bureau of Labor Statistics, California Department of Finance

Comparison of Minimum Wage to CA Population (1970-2006)

y = 0.04x + 0.07

R2 = 0.18p = 0.01

9.5%

10.0%

10.5%

11.0%

11.5%

12.0%

12.5%

13.0%

0.80 0.90 1.00 1.10 1.20 1.30 1.40

Real CA Min Wage as % of Real US Min Wage

CA

Po

pu

lati

on

as

% o

f U

S P

op

ula

tio

n

When looking at data, beware:

1. Correlation is not (necessarily) causality;

2. Outliers can skew results.

18


Comparison of Minimum Wage to CA Unemployment (1970-2004)

y = -0.04x + 0.09

R2 = 0.01p = 0.62

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

35% 37% 39% 41% 43% 45% 47% 49% 51% 53%

Real CA Min Wage as % of Real US Avg Hourly Wage

CA

Un

em

plo

ym

en

t

R2 = % of variation in the outcome variable (CA unemployment) that is explained by the

explanatory variable (CA minimum wage).

p = probability that any apparent relationship between the explanatory and outcome variables is due to random chance as opposed to a true relationship.

19


Comparison of Min. Wage to Unemp Rate Across States (2006)

y = 0.001x + 0.04

R2 = 0.01p = 0.41

0%

1%

2%

3%

4%

5%

6%

7%

8%

$4.00 $5.00 $6.00 $7.00 $8.00 $9.00 $10.00

Minimum Wage (comparable wage index adjusted)

Un

emp

loym

ent

Rat

e

20Source: Statistical Abstract of the United States, and Bureau of Labor Statistics

College Education (1984-2004)

y = 0.003x + 0.02

R2 = 0.0002p = 0.95

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

0.3 0.32 0.34 0.36 0.38 0.4 0.42 0.44

Min Wage as Fraction of Avg Hourly Wage

Un

emp

loym

ent

Rat

e


HS Education (1984-2004)

y = 0.23x - 0.03

R2 = 0.18p = 0.05

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

0.3 0.32 0.34 0.36 0.38 0.4 0.42 0.44


Un

emp

loym

ent

Rat

e


Less than HS Education (1984-2004)

y = 0.46x - 0.07

R2 = 0.26p = 0.02

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

0.3 0.32 0.34 0.36 0.38 0.4 0.42 0.44


Un

emp

loym

ent

Rat

e

23Source: Bureau of Labor Statistics

Unemployment for Teenagers Relative to Adults (1964-2004)

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

3.3

0.3 0.32 0.34 0.36 0.38 0.4 0.42 0.44 0.46 0.48Minimum Wage as Percentage of Average Hourly Earnings

Un

emp

loym

ent

Po

pu

lati

on

Rat

io f

or

16-1

9 Y

ear

Old

s as

Per

cen

tag

e o

f 20

-64

Yea

r O

lds

Minimum Wage as Percentage of Average Hourly Wage

Unem

plo

ym

ent

Popu

lati

on

Rati

o f

or

16-1

9

Year

Old

s as

a P

erc

enta

ge o

f R

ati

o f

or

20

-64

Year

Old

s

24


Comparison of Minimum Wage to CA Inflation (1970-2004)

y = 0.44x - 0.14

R2 = 0.28p = 0.001

0%

2%

4%

6%

8%

10%

12%

14%

16%

35% 37% 39% 41% 43% 45% 47% 49% 51% 53%

Real CA Min Wage as % of Real US Avg Hourly Wage

CA

In

flat

ion

25


Comparison of Min. Wage to Income Distribution Across States (2006)

y = -0.005x + 0.50

R2 = 0.02p = 0.35

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

$4.00 $5.00 $6.00 $7.00 $8.00 $9.00 $10.00

Minimum Wage (adjusted for comparable wage index)

Gin

i R

atio

(0

= e

qu

itab

le,

1 =

in

equ

itab

le)

26

Bringing the Dismal Science to Life: Lessons from Economic

Experiments

2007 Capital Campus California Retreat

January 19-20, 2007

Documents

1 Bringing the Dismal Science to Life: Lessons from Economic Experiments 2007 Capital Campus California Retreat January 19-20, 2007