Experimental Economics

An alternative Introduction R obert F. Veszteg

Waseda University

October 1, 2013

R obert F. Veszteg

A beauty contest

Imagine a beauty contest in which you are asked to choose the most beautiful contestant.

The most often chosen candidate will be the winner of the beauty contest, and

those who chose her are eligible for a prize.

R obert F. Veszteg

A Keynesian beauty contest

It is not a case of choosing those which, to the best of ones judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fth and higher degrees. Keynes, J.M., The General Theory of Employment, Interest and Money, 1936 (p.140)

R obert F. Veszteg

Keynes - the money manager

from http://www.maynardkeynes.org/keynes-the-investor.html

Keyness fame as an economist and his personal success in the markets led to his being oered and accepting positions managing money on behalf of Kings College, Cambridge and the National Mutual and the Provincial Insurance companies. Keynes became rst bursar of Kings in 1924, taking on responsibility for the colleges nancial well being. He decided to concentrate all of the colleges resources over which he had discretion into a fund called the Chest.

R obert F. Veszteg

Keynes - the money manager

The Chests initial capital was GBP 30,000. By the time Keynes died in 1946 the fund had grown to GBP 380,000 - an annual compounding rate of just over 12 per cent. This performance was achieved during a period that encompassed both the crash of 1929 and the build up to World War Two, both of which proved disastrous for British stocks. In the same period of time, the British stock market fell 15 per cent. The growth in the value of the Chest Fund was entirely due to capital appreciation. There was no dividend reinvestment because Keynes spent all of the dividends on the college.

R obert F. Veszteg

A game-theoretical beauty contest

Each of n 2 players simultaneously chooses a real number from the [0; 100] interval.

The winner is the player whose number is closest to the mean of all chosen numbers.

2 3

times

The winner gains a xed prize. If there is a tie, the prize is split amongst those who tie.

R obert F. Veszteg

A beauty-contest experiment

Observe the rules of the game-theoretical beauty contest and play!

Which number do you choose?

R obert F. Veszteg

Solution 1 to the beauty-contest game

Note that the beauty-contest game is dominance solvable, i.e. the iterated elimination of (weakly) dominated strategies will lead you to the Nash equilibrium of the game. Step 1: Eliminate all numbers in Step 2: Eliminate all numbers in Step n: Eliminate all numbers in
2 3

100; 100 .
2 2 3 2 n 3

100; 100 . 100; 100 .

When n you are left with only one strategy, 0, which players should be choosing in the Nash equilibrium.

R obert F. Veszteg

Solution 2 to the beauty-contest game

Based on a story of iterated best replies. Level 0: Choose a number randomly from [0; 100]. Level 1: Play best response to Level 0 and choose 50 2 3. Level 2: Play best response to Level 1 and choose 50
2 2 3 . 2 n 3 .

Level n: Play best response to Level n 1 and choose 50

When n you are left with the strategy, 0, which players should be choosing in the Nash equilibrium.

R obert F. Veszteg

Experimental evidence (Nagel, 1995)

R obert F. Veszteg

Experimental evidence (Nagel, 1995)

R obert F. Veszteg

Experimental evidence (Nagel, 1995)

Figure : Choices in the rst period of a 2 3 beauty-contest game.

R obert F. Veszteg

Experimental evidence (Nagel, 1995)

Figure : Relative frequencies of choices in the rst period of a 2 3 beauty-contest game.

R obert F. Veszteg

Experimental evidence (Nagel, 1995)

Figure : Observations over time for a 2 3 beauty-contest game.

R obert F. Veszteg

Experimental evidence (Nagel, 1995)

Figure : Observations over time for a 2 3 beauty-contest game.

R obert F. Veszteg

Experimental evidence (Nagel, 1995)

Figure : Observations over time for a 2 3 beauty-contest game.

R obert F. Veszteg

Conclusions

Game-theoretical reasoning vs. boundedly rational behavior

The reference point seems to be 50 and not 100. The process of iteration is nite and not innite. Over time the chosen strategies approach the equilibrium.

R obert F. Veszteg

Follow-ups and extensions

Other reasoning techniques to test: xed-point argument iterated elimination of dominated strategies iterated best reply (Nagel, 1995; Stahl, 1996; Ho et al., 1998) best reply to probability distributions over dierent types (Stahl, 1998) brainwork does not work, lets run an experiment to nd an empirical target number

R obert F. Veszteg

Follow-ups and extensions

Changes in the rules of the game: n = 2 vs. n > 2 (Grosskopf and Nagel, 2001) p < 1 (as p =
1 2

or p = 2 3 ) vs. p > 1 (Nagel, 1995)

real numbers as strategies vs. integers (Lopez, 2002) boundary vs. interior equilibrium (constant added to the average; Camerer and Ho, 1999)

R obert F. Veszteg

Follow-ups and extensions

Heterogeneity (experiments through newspapers; Bosch-Domenech et al., 2002): dierent subject pools high rewards (EUR 500-1000) thousands of players (>10,000) long time to think

R obert F. Veszteg

References

Nagel, R. (2009) Games, in: Friedman, D., Cassar, A. (2009) Economics Lab: An Intensive Course in Experimental Economics, Routledge: Taylor & Francis Group.

Nagel, R. (1995) Unraveling in Guessing Games: An Experimental Study, The American Economic Review 85:1313-1326.

R obert F. Veszteg