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Market Efficiency Experiment based on Ted Bergstrom and John Miller, Experiments with Economic Principles, 2nd edition Assignment is due: Saturday, February 15, 11:59pm. Introduction. We conducted three separate sessions in this experiment. In Sessions 1 and 2, traders were allowed to make the best deal they possibly could, without any restrictions placed upon who they could trade with. In Session 3, the government imposed restrictions on market participants, matching certain types of buyers and sellers. In Session 3, the distribution of buyer and seller types was exactly the same as in Session 2 [see Table 1]. Participants were still free to negotiate the best deal they could, subject to the government constraints. The purpose is to see what effects government intervention has on a competitive market. Table 1. Distribution of Types of Market Participants GOVT 2301 Type of Trader No. in Session 1 No. in Sessions 2 & 3 Low-Cost MWTS ($10) 8 5 High-Cost MWTS ($30) 4 9 High-Value MWTP ($40) 5 9 Low-Value MWTP ($20) 10 4 The table above indicates two types of participants in our experimental market: suppliers and demanders (or sellers and buyers, if you prefer). To be more precise, there were two types of suppliers: those with “low” seller costs of $10 and those with “high” sellers costs of $30. The seller costs represent the costs of producing a cardboard rectangle, therefore, sellers would not be willing to take an order for a cardboard rectangle for any amount less than their seller costs. Their seller costs constitute their minimum-willingness-to-sell (MWTS) or seller’s reservation price. We similarly had two types of demanders: those with a “high” buyer value of $40 and those with a “low” buyer value of $20. The buyer values represent the monetary equivalent of the amount of satisfaction buyers derive from consuming cardboard rectangles. Their buyer values represent their maximum-willingness-to-pay (MWTP), or buyer’s reservation price, for a cardboard rectangle. Table 2. Market Efficiency Experiment, Summary of Results Session 1 Session 2 Session 3 Average Price $22 $27 $32 Number of Transactions 8 9 7 Total Profits of All Sellers $97 $77 $72 Total Surplus of All Consumers $83 $93 $58 Total Profits of All Participants $180 $170 $140 To see how the demand schedule below was determined, click your mouse to reveal the questions we need to ask (and their answers): If the price for cardboard was above $40, how many of our 15 demanders would be willing to buy? 0 If the price for cardboard was exactly $40, how many of our 15 demanders would be indifferent to buying? 5 If the price for cardboard was exactly $20, how many of our 15 demanders would be indifferent to buying? 15 If the price for cardboard ranged between $20 and $40, how many of our 15 demanders would be willing to buy? If the price for cardboard was less than $20, how many of our 15 demanders would be willing to buy? 15 Session 1 Demand Schedule Price Range Amount Demanded P > $40 0 $20 < P < $40 5 P < $20 15 5 To see how the supply schedule below was determined, click your mouse to reveal the questions we need to ask (and their answers): If the price for cardboard was less than $10, how many of our 15 sellers would be willing to sell? 0 If the price for cardboard was exactly $10, how many of our 15 sellers would be indifferent to selling? 8 If the price for cardboard was exactly $30, how many of our 15 sellers would be indifferent to selling? 12 If the price for cardboard ranged between $10 and $30, how many of our 15 sellers would be willing to sell? If the price for cardboard was more than $30, how many of our 15 sellers would be willing to sell? 12 Session 1 Supply Schedule Price Range Amount Supplied P < $10 0 $10 < P < $30 8 P > $30 12 8 Figure 1: Supply and Demand for Cardboard, Session 1 45 Consumers’ Surplus 40 Price of Cardboard Rectangles Click through to see what this model predicts [1] price and quantity, [2]surpluses of all consumers, [3] profits of all sellers, and [4] total profits and surpluses to all market participants to be. First we construct the demand and supply curves from the schedules developed on the previous two slides. Recall the questions posed. ($40-$20) x 5 35 = $100 30 Pricee = $20 25 Quantitye = 8 20 Sellers’ Profits 15 ($20-$10) x 8 10 = $80 5 0 5 10 15 Quantity of Cardboard Rectangles 20 Total Profits = $100 + 80 = $180 Homework Problems. Now it is your turn to do some analysis. I will walk you through, question by question. Submit your answers by e-mail (wfeagin@templejc.edu). When typing your answers, be sure to indicate the numbers of the questions you are answering. For example: 1. My answer to Q1 2. My answer to Q2. 3. My answer to Q3. ….and so on. There are 37 questions to be answered in this assignment (Q1-Q37). Use the information provided in Table 1 for Sessions 2 & 3 to answer the following questions (click through) and complete the demand schedule for Sessions 2 & 3: If the price for cardboard was above $40, how many of our 13 demanders would be willing to buy? Q1 If the price for cardboard was exactly $40, how many of our 13 demanders would be indifferent to buying? Q4 If the price for cardboard was exactly $20, how many of our 13 demanders would be indifferent to buying? Q5 If the price for cardboard ranged between $20 and $40, how many of our 13 demanders would be willing to buy? If the price for cardboard was less than $20, how many of our 13 demanders would be willing to buy? Q3 Sessions 2 & 3 Demand Schedule Price Range Amount Demanded P > $40 Q6 $20 < P < $40 Q7 P < $20 Q8 Q2 Use the information provided in Table 1 for Sessions 2 & 3 to answer the following questions (click through) and complete the supply schedule for Sessions 2 & 3: If the price for cardboard was less than $10, how many of our 14 sellers would be willing to sell? Q9 If the price for cardboard was exactly $10, how many of our 14 sellers would be indifferent to selling? Q12 If the price for cardboard was exactly $30, how many of our 14 sellers would be indifferent to selling? Q13 If the price for cardboard ranged between $10 and $30, how many of our 14 sellers would be willing to sell? If the price for cardboard was more than $30, how many of our 14 sellers would be willing to sell? Q11 Sessions 2 & 3 Supply Schedule Price Range Amount Supplied P < $10 Q14 $10 < P < $30 Q15 P > $30 Q16 Q10 Figure 2: Supply & Demand for Cardboard, Sessions 2 & 3 Consumers’ Surplus 45 40 Price of Cardboard Rectangles Click through to see what this model predicts [1] price and quantity, [2]surpluses of all consumers, [3] profits of all sellers, and [4] total profits and surpluses to all market participants to be. I’ll draw the graph, but you have to answer the questions. (Q19-Q20) x Q21 35 = Q22 30 Pricee = Q17 25 Quantitye = Q18 20 Sellers’ Profits 15 (Q23-Q24) x Q25 10 = Q26 5 0 5 10 15 Quantity of Cardboard Rectangles 20 Total Profits = Q27 + Q28 = Q29 Market Efficiency Economists are mainly interested in the efficiency of market outcomes. A market outcome is said to be efficient if the sum of all profits made by participants in the market is as large as possible. A market outcome is inefficient if some other possible arrangement of trades will result in higher total profits/surpluses for the market. If one set of institutional arrangements leads to an inefficient outcome, it may be possible find alternative institutions that generate higher total profits/surpluses. In our experimental market, market efficiency is the actual total profits of market participants expressed as a percentage of the highest possible amount of profits that could be achieved in the market. If the total profits actually made by market participants are equal to the maximum possible amount, then the market is said to be 100% efficient. If the total profits actually made are only 80% of the maximum possible amount, then the market is said to be 80% efficient, and so on. What were the actual total profits/surpluses of all market participants in Session 2? Q30 [see Table 2] What were the maximum possible profits in Session 2 & 3? Q31 [see Figure 2] How efficient was the experimental market outcome in Session 2 [express as a percentage]? Q32 What were the actual total profits/surpluses of all market participants in Session 3? Q33 [see Table 2] How efficient was the experimental market outcome in Session 3 [express as a percentage]? Q34 Finally, economists contend that in markets where the profits of buyers and sellers depend only on the trades that they themselves make, competitive equilibrium is the most efficient outcome. We may state this important result as a proposition: • Proposition: The sum of profits/surpluses of sellers and buyers in competitive equilibrium is at least as large as it would be with any other arrangement of trades. Do you find that this proposition is supported by the outcomes in Sessions 2 & 3 of our experimental market? Do not simply answer “yes” or “no.” Elaborate on your answer. Q35 What do you believe the premise underlying the proposition stated above to be? What assumption does the proposition make about a market economy? Elaborate on your answer. Q36 What do our experimental outcomes imply about the role of government in a capitalist economy? Elaborate on your answer. Q37