Experimental markets with search frictions and network externalities

The project address small experimental markets with information frictions, coordination frictions, network effects, and bargaining. In small markets participants cannot take the environment as given, but needs to behave strategically towards others. In one part of the project we explore small markets in which a small number of sellers post prices simultaneously. Subsequently, the prices are observed by a fraction of the buyers in the market. If sellers are capacity constrained, queues may form. Buyers may experience being rationed. Buyers make a trade-off between price and probability of being served. Sellers take this in to account when posting. If not all buyers observe the posted prices, sellers also take in to account that it's possible to set the "rip-off" price and target the uninformed. We find that subjects in the lab often converge fast to the equilibrium in such markets. Models are good "as if" explanations of behavior. However, we want to go deeper and understand how subjects learn to play the equilibrium, and when learning does not lead to equilibrium. These situations are of relevance for our understanding of labor markets and many markets for consumer goods. In another part of the project we explore choice between alternative technologies in the presence of network effects. My gain from a choice of technology is conditioned on how many others of a given "type" choosing as me. Consider an island fable as illustration. There are two islands ("technologies"). Two of the four agents are seller-"types", the other two are buyer-"types". One island is far away the other one close. Agents simultaneously choose the island to trade on. Intuitively there are two equilibria: one were all agents locate on the close island, the other one were they all locate on the far away island. In these constellations no agent has an incentive to relocate unilaterally (a relocating agent would not transact). Still, it is better for all agents to locate on the near rather than the far off island. We find that deductive principles of equilibrium selection does not explain behavior, but that simple (non-rational) learning rules do. We also find that giving initial monopoly to the inferior technology (the far off island) can prevent agents selecting the superior technology. These situations are of relevance for our understanding of for instance shifts from dirty to green technology. In a third part of the project choice of technology depends both on the opponents choice and on private information about own type. Type characterizes how useful the alternative technology is for the agent. High types profit on moving to the alternative technology independent of the opponents choice, low types never move to the alternative technology. Types in a mid interval move only if the opponent does. If an agent has moved in the first stage, he cannot go back. Thus, we can get situations in which agents that would profit on moving does not move. We find that subjects in the high end of the mid interval - in opposition to theory - has a tendency to move. We explain this by noisy decision making. These situations are of relevance for many phenomenon, from choice of industry standards to choice of political platforms. In a fourth part we explore bargaining behavior when bargainers have earned a share of the surplus. Earned share are worthless outside of the match; they are "relationship-specific". According to standard theory, relative shares are irrelevant for bargaining. We find that they are not irrelevant in the lab. We explain their relevance by formulating a bargaining model in which earned shares is a reference point, and bargainers have loss averse preferences. These situations have general interest, given the pervasiveness of bargaining as a decision rule in society. The PhD in the project explores theoretically whether search frictions can lead to discrimination (in hiring and wages) even in small markets, and what effects minimum wages will have. The theory will be taken to the lab.

The project will design and analyze experimental markets with search costs, and experimental markets with network externalities. The aim is to understand: i) the conditions under which markets with network externalities may lead to coordination failure and lock in, and ii) the conditions under which markets with search costs converge to / diverge from the behavior predicted by search theory. To achieve these aims the project assembles internationally acclaimed expertise on the relevant market theorie s; on learning theories; on experimental design; and on behavioral economics. The project budget sums to 7,9 million NOK over a four year period. Expected primary outputs are six articles in high quality research journals, plus one PhD-dissertation. We also expect the project to produce articles in the popular press, an annual workshop, and broad participation in activities of international research networks.