Markets

Tantonnement

a fictional scenario where an auctioneer announces price; each buyer & seller states their willingness to pay --> intersection = market equilibrium - markets fail IRL: false trades and sub optimal trades

Inducing Demand

redemption function: how much experimenters pay participants if they buy units of the good - Utility functions can be linear or non-linear --> must be monotonic $ = Vi(xi) Profit = Vi(xi) - p(xi)

Q: Do market prices track changes in Supply and Demand? → Cycle S and D

*look at graph* Yes

Q: Does inequality affect convergence? → Box Design

*look at graph* - PS much larger than CS, box shaped schedules - Competitive markets adhere to eq. price regardless of "fairness" of surpluses

Market Theory

- Assumed to be a-institutional --> tantonnement

Posted Price Institution Rules

- Beginning of period, sellers commit to a price offer → Fix max quantity & price - Vector of prices revealed to all market participants (but not the sellers' limit Q) - Buyers are randomly + sequentially selected → - Choose the (still) available price offers, buy as many units as they want Note: Sellers receive LIMITED info about buyers' willingness to pay (compared to DA) = Buyers are "silent" and have little market power

Excess Rent Hypothesis: Does convergence depend on the shapes of supply & demand curves?

- Convergence from above IF CS > PS - Convergence from below IF PS > CS - Rent captured by side with smaller surplus in equilibrium

Wall Street Double Auction Performance Measures

- Convergence: prices converge to competitive equilibrium - Efficiency: Converges to maximum PS + CS possible - Distribution: how are gains distributed to buyers & sellers?

DA vs. PO (Efficiency)

- DA much more efficient than PO in early periods → Final period PO efficiency ~100% - PO: High prices in early periods cause low trading volume

Wall Street Double Auction Set up

- Each buyer paid Profit = Vi(xi) - p(xi) → Demand schedule - Each seller paid Profit = p*xj - cjxj → Supply schedule - Market day: Limited time for trading Buyers make bids, sellers make offer, for specific quantity + price - Improvement rule: A new bid must be better (higher) than the highest standing bid. A new offer must be better (lower) than the lowest standing offer. → Speeds up convergence - Individuals only know their own Bi(xi) or Si(xi) schedules

Asset Markets (Double Auction) Smith, Suchanek, Williams 1988 Results

- Inexperienced and professional traders Do trade (initially above fundamental value, then at fundamental value, then trade less/no trade) - If rationality not common knowledge, even rational traders have incentive to speculate

Chamberlin (1948)

- Market experiment where prices and quantities didn't converge to competitive equilibrium - Subjects bargained bilaterally, trading prices written on blackboard -Bilateral bargaining subject to each agent's persuasive ability(?) → Too much variation Chamberlin wanted to refute competitive model

Asset Markets (Double Auction) Smith, Suchanek, Williams 1988

- Subjects endowed with assets and cash → Transferrable to future periods - Subjects paid their total cash holdings at end of final period T - After last period, assets are worthless (no more dividends or trading) - Assets may be traded in a double auction - Assets yield dividends every period: 0, 8, 26, or 60 cents of equal probability → Expected value = 24 cents

Monopoly & Market Structure

- monopolies lead to decreased welfare, but depends on institution --> Double Auction Institution ALMOST always leads to 100% efficiency --> monopoly cant exert monopoly power -Both Buyer + Seller have some market power

Assumptions of Perfect Competition

1. Agents are rational and selfish utility or profit maximizers 2. homogenous well defined good is traded 3. numerous firms & consumers 4. agents are price takers

Excess Rent Hypothesis: Summary

The market works under looser conditions than expected 1. Few agents / traders required 2. Agents do not have to have perfect knowledge of supply + demand 3. Price-taking behavior is not required (everyone in double auction is a price taker + price maker)

Vernon Smith - Double Auction

Changes to Chamberlin 1. oral double auction instead of bilateral bargaining 2. stationary replication --> market can equilibrate over time

Posted Price Institution Results

Convergence: Slow Efficiency: Low initially → High later Excess rent hypothesis: Convergence always from above, rent to sellers, buyers have less market power Box Design: PO (posted offer) doesn't pick up / track changes in D and S

Inducing Supply

Cost function: Producing one x costs c. Assume all units are sold at price p Profit = p*xj - cj(xj)

DA vs. PO (Responsiveness to Demand Shocks)

DA: Most prices below CE - Demand Shock → Most prices above CE PO: No relationship between Actual and CE prices

Asset Markets (Double Auction) Smith, Suchanek, Williams 1988 Predictions

If traders are rational & risk neutral - then there should be no trade; trade only at expected fundamental value of the asset - Risk-loving traders = 0.24 + E (small) per period - Risk-averse traders = 0.24 - E per period - Max price of asset = (T-t)(0.24 + E) - Asset prices should never exceed (T-t)(0.60) <-- Above max dividend payment for remaining lifetime of asset

Posted Price Institution

firms compete by posting prices, then consumers shop eg. Bertrand competition, price competition in retail sales

Walrasian Convergence

flatter demand and supply functions converge faster because excess supply/demand in one market is greater than the other