The Encyclopedia of Libertarianism

Economics, Experimental

Experimental economics applies laboratory methods of inquiry to the study of motivated human behavior in social contexts governed by explicit or implicit rules. Explicit rules may be defined by experimental control and information, or the rules may be shaped by market institutions in which cash-motivated people buy or sell abstract rights to consume or produce commodities and services within some particular technological context. Implicit rules refer to the norms, traditions, and habits that people bring to the laboratory as part of their cultural and biological evolutionary heritage; they are not normally controlled by the experimenter. By devising and running markets and other exchange systems in the laboratory, and through the use of actual people, experimental economics helps us better understand why markets and social exchange systems work the way they do.

Generally, we can think of experimental outcomes as the consequence of behavior governed by individual choice, driven by the economic environment, and mediated by the language and rules that govern interactions supplied by the institution. The economic environment consists of preferences, knowledge, skills, and resource constraints. Abstractly, institutions map the messages (e.g., bids, asks, acceptances, words, and actions) that give rise to our outcomes.

Under the operation of these rules or norms, people choose messages consistent with their economic environment. A well-established finding in experimental economics is that institutions matter because the rules matter, and the rules matter because incentives matter. However, the incentives to which people respond are sometimes not those one would expect based on the canons of economic theory. It turns out that people are often better, and sometimes worse, at achieving gains for themselves and others than is predicted by standard forms of rational analysis. These contradictions provide important clues to the implicit rules that people may follow and can motivate new theoretical hypotheses that can then be examined in the laboratory.

The design of experiments is motivated by two quite distinct concepts of a rational order. Rejecting or denying either of these should not lead one to assume that the actor’s decision was irrational. Thus, if people in certain contexts choose outcomes yielding the smaller of two rewards, we ask why, rather than conclude that this choice is irrational. The first concept of a rational order derives from today’s standard socioeconomic science model and dates back to the 17th century. This model is a product of what Hayek has called constructivist rationalism, which, in its modern form, stems from Descartes, who argued that all worthwhile social institutions were and should be created by conscious deductive processes of human reason. Cartesian rationalism provisionally requires agents to possess complete information—indeed, far more than could ever be given to one mind. In economics, the resulting analytical exercises, while yielding insightful theorems, are designed to aid and sharpen thinking in the form of “if–then” parables.

Yet these exercises may not approximate the level of ignorance that has given shape to real institutions. Our theories and thought processes about social systems involve the conscious and deliberate use of reason. Therefore, it is necessary to constantly remind ourselves that human activity is diffused and dominated by unconscious, autonomic, and neuropsychological systems that enable people to function effectively without always calling on the brain’s scarcest resource: attention and reasoning circuitry. This property is an important one of the brain. These considerations lead to the second concept of a rational order, an undesigned ecological system that emerges out of cultural and biological evolutionary processes: homegrown principles of action, norms, traditions, and morality. Thus, “the rules of morality … are not the conclusions of our reason.” According to Hume, who was concerned with the limits of reason, rationality was a phenomenon that reason discovers in emergent institutions. Context matters because experience matters, and our memory matters because cultural and biological evolutionary processes matter. Hence, context must be regarded as crucial in small-group experiments.

Adam Smith expressed the idea of spontaneously generated orders in both The Wealth of Nations and The Theory of Moral Sentiments. It is the antithesis of the Cartesian belief that, if an observed social mechanism is functional, somebody in the unrecorded past must have used reason consciously to create it to serve its currently perceived purpose. In experimental economics, the Scottish tradition is represented by the discovery of Smith’s notion of order in numerous studies of existing market institutions, such as the double auction. To paraphrase Adam Smith, people in these experiments are led to promote welfare-enhancing social ends that are not part of their conscious intention. This principle is supported by hundreds of experiments whose environments and institutions exceed the capacity of formal game-theoretic analysis. But they do not exceed the functional capacity of collectives of incompletely informed human decision makers whose mental algorithms coordinate behavior through the rules of the institution—social algorithms—to generate high levels of measured performance. Acknowledging and recognizing the workings of unseen processes are essential to the growth of our understanding of social phenomena, and we must strive not to exclude them from our inquiry if we are to have any hope of understanding data inside or outside of the laboratory.

 

Further Readings

Hoffman, Elizabeth, Kevin McCabe, Keith Shachat, and Vernon L. Smith. “Preferences, Property Rights and Anonymity in Bargaining Games.” Games and Economic Behavior 7 no. 3 (November 1994): 346–380.

Smith, Vernon L. “Constructivist and Ecological Rationality in Economics.” American Economic Review 93 no. 3 (June 2003): 465–508.

———. “Markets as Economizers of Information: Experimental Examination of the ‘Hayek Hypothesis.’” Economic Inquiry 20 no. 2 (April 1982): 165–179.

———. “Microeconomic Systems as an Experimental Science.” American Economic Review 72 no. 5 (December 1982): 923–955.

———. “Two Faces of Adam Smith.” Southern Economic Journal 65 no. 1 (July 1998): 1–19.

Originally published .