What is experimental economics?

Suppose you get on an airplane and the pilot announces, “In a few minutes we’ll be taking off on the inaugural flight of this plane. We expect it to cut your travel time in half. We’ve haven’t actually tested the plane—but our panel of experts is confident it will be the fastest, safest plane ever built. Fasten your seatbelts.”

Would you stay on that plane? I doubt it. Before airplanes are approved for commercial travel, they’re tested in wind tunnels and flown by test pilots, to work out all the kinks. Why would an airline operate an untested plane when the costs of failure are so great—and can easily be avoided?

We can ask the same question about new public policies. Changes in government policies—such as new fisheries regulations—can have major effects on people’s lives. Should we support a proposed but untested policy based solely on the testimony of experts, or people with some stake in the outcome?

That’s where the growing field of experimental economics comes in. Experimental economics uses controlled, scientific experiments to test what choices people actually make in specific circumstances. In 2002, Vernon Smith won the Nobel Prize in Economics for developing a methodology that allows researchers to test proposed new policies before they are implemented.

Here’s how it works. Researchers design an experiment that captures the key features of some “real world” market under study. People who have agreed to take part in the experiment are assigned the roles of buyers and sellers making trades. Participants have an incentive to think carefully about their decisions, since the money they earn from trading is theirs to keep.

During the experiment, researchers can change the rules of exchange and the incentives—and by observing how the participants’ behavior changes as the rules or incentives change, they can examine the effects of policy changes. They can then compare the actual results of the experiment with theoretical predictions about how people would respond to some policy change.

Besides experiments in the laboratory, Resource Economics professors also use experiments in classrooms, to give students hands-on experience with the power of markets and incentives. Students see how economics can explain what goes on in the real world—and how those same economic concepts can help policymakers make better decisions.

Experimental economics could be useful in many policy debates. We might, for example, want to study the relative merits of different carbon trading programs, or the incentive properties of different fisheries management proposals. Other projects which have been undertaken by members of our lab include investigations into theoretical solutions to noncompliance with environmental regulation as well as using experimental economics to discriminate between competing models that may explain firms’ anticompetitive behavior.

In the last 20 years or so, the field of experimental economics has undergone tremendous growth nationally and internationally. The experimental economics program in the Department of Resource Economics brings the benefits of this growing field to UMass.