Book Review on "The Art of Experimental Economics"

By Gary Charles and Mark Pingle

Submitted by - Vinish Chandra

Roll number - 2315124

Course & Section - B.A Hons. Economics

The Art of experimental economics involves conducting

experiments under controlled conditions to test
economic theories and behaviors. It's an empirical
approach that lets economists observe, analyze, and
understand decision-making processes and market
dynamics in a laboratory setting.
Vernon L. Smith's experimental study on competitive
market behavior investigates how people act in a
controlled market environment. Smith's experiments
placed participants in mock markets where they could
buy and sell, observing their behavior and testing
economic theories. These studies helped confirm that,
despite simplified conditions and limited information,
markets tend to move towards the theoretical
equilibrium of supply and demand predicted by classical
economics, showcasing the robustness of competitive
markets in resource allocation.
Werner Güth's experimental study of ultimatum
bargaining examines decision-making in a game
where one player proposes a division of money and
the second can either accept or reject it. If rejected
, both receive nothing.
 The study highlights that people often reject unfair
offers, challenging the assumption that individuals
are purely self-interested and indicating that
fairness and punishment of greed can influence
economic decisions.
Daniel Kahneman's research on the endowment effect
and the Coase theorem tests the hypothesis that
ownership biases value perception. The endowment
effect suggests people assign higher value to items they
own. Kahneman's experiments challenge the Coase
theorem, which posits that rights can be traded to
achieve efficiency, by demonstrating that valuation
discrepancies due to the endowment effect can impede
such efficient exchanges.
Rosiemarie Nagel's study on unraveling in guessing
games investigates human behavior in a common game
where participants guess a number from 0 to 100,
aiming to pick two-thirds of the average guess. The "
unraveling" occurs as rational players iteratively lower
their guesses, considering others' rationality. The study
shows that while some guesses approach the game's
theoretical equilibrium (zero), many do not, highlighting
the complexity of actual versus predicted rational
behaviors.
Ernst Fehr and Simon Gächter's research explores how
cooperation and punishment mechanisms affect
contribution to public goods. Their experiments show
that when individuals can penalize others at a cost to
themselves, overall contributions to the collective good
increase. People are willing to punish free-riders, even at
personal expense, leading to enhanced cooperation and
societal benefit, illustrating the critical role of
sanctioning systems in upholding public cooperation.
Here are few examples:-

1. Mutual Monitoring: When participants can observe

contributions from others, they often adjust their
behavior, sometimes contributing more to match or
outdo peers.
2. **Reward Systems:** Not only punishment but also
rewards can foster cooperation. Participants who can
reward others for contributing may do so to encourage
continued investment in the public good.

Charles Holt and Susan Laury's study on risk aversion

and incentive effects examines how people's willingness
to take risks changes in response to the scale of
potential rewards. They find that as potential payouts
increase, individuals exhibit greater risk aversion,
preferring sure, smaller wins over gambles with higher
stakes. Their experiment is essential in understanding
how economic incentives can shape decision-making
under uncertainty.

"Promises and Partnership" by Charness and

Dufwenberg explores how the power of non-binding
promises affects cooperative behavior. Their research
shows that when individuals verbally commit to an
action, like contributing to a public good, they are
more likely to follow through. This indicates that
despite the absence of formal enforcement
mechanisms, the mere act of promising can
strengthen partnerships and significantly increase the
likelihood of cooperative outcomes in social and
economic interactions.
The Hidden Cost of Control" by Armin Falk and
Michael Kosfeld investigates the impact of
control mechanisms on employee motivation.
Their research reveals that when employers
implement strict controls, it can imply distrust,
undermining employees' intrinsic motivation.
Consequently, this may decrease their work
performance, representing a hidden cost of control
. The study suggests a careful balance between
necessary oversight and maintaining trust to avoid
negative effects on morale and productivity. It
contributes to a broader understanding of
motivation in economic relationships.
In "Do Women Shy Away from Competition? Do
Men Compete Too Much?" by Muriel Niederle and
Lise Vesterlund, gender differences in competitive
behavior are examined. Their study finds that
women are less likely to choose competitive
environments, not due to lack of ability, but
possibly due to lower confidence or aversion to
competition. Conversely, men are more inclined to
enter competitions, even when it may not be in
their best interest. This research highlights
important implications for gender disparities in
labor markets and decision-making strategies.
In an experiment by Niederle and Vesterlund,
participants completed a task with the option to
be paid based on either their individual
performance or through a tournament-style
competition. Despite similar abilities, women were
less likely to opt for the competitive payment
scheme, while men chose it more often, even
when their chances of winning were not as high.
This indicated that men overestimated their
competitive advantage or had a stronger
preference for competition, whereas women
opted out even if they had a good chance of
winning.
Conclusion

The Art of Experimental Economics illustrates

the vital role that carefully designed
experiments play in understanding economic
behavior. It combines insights into human
psychology with economic theory to test
hypotheses in controlled settings, revealing
the complexity of decision-making processes.
By observing how real people react to
incentives, norms, and information,
experimental economics can challenge
traditional assumptions, highlight the
influence of social factors, and inform policy
design. It provides a robust, empirical
foundation for economic theory and a clearer
picture of human behavior in economic
contexts.