What Economists Really Do and Why it Matters - Essay Example

College Experimental economics Some economic questions are hard to answer using the field data or during the field work. It isalso hard to find environments simple enough to test the predictions of a certain theory and information not readily obtained from the field is required to come to a conclusion. Such data, in a laboratory setting can be available through replication. So, experimental economics is important in testing predictions and offers a controlled environment for this purpose. Some of the questions which are dealt with in a laboratory setting and that which would not be answered in the field are; for a market to be competitive, how many traders are required and in bargaining, does fairness play any role and if so, can individuals be paid to act contrary? Just like most of the other sciences, Economics as a subject involving observation. Hence, the theories in Economics attempt to explain the activity in a particular market. Traditionally, theories pertaining to economics have been tested using the statistical data from the current markets. Even though those in the study of Economics are sometimes able to distinguish the related variables in a specific study, natural data may fail to permit tests used in theories. The reason for this is that varying historical events and circumstances only occur by chance. These problems have increased especially so, that the models used have become more complex and precise. (Douglas, et al, 1992, Pg 3). Because of such challenges, Economists have forced to test theories on data based on usability of such theories. In early 1950’s and late 1940’s a group of economists thought separately that laboratory methods could be used in the subject of economics, just like other sciences. One of them Edward Chamberlin brought forward the subjects using a streamlined market version. The resultant literature focused on the classical price prediction theory. The experimental Economics came about as a result of testing the effects of the game theory which proved uncooperative in a way. The game theory was used in situations where it least resembled the actual market. The game theory, involved use of a tabular form in calculations, which in a way, disregarded much of the demand structure and cost in a certain market. Distinctive features There are a number of reasons that economists give for conducting economic experiments. This reasons range from the need to confirm theories to persuasion of decision makers. It is from these two reasons that others emerge, like the testing the failure of a certain theory. Wilde (1981) and Smith (1982) were particularly instrumental in laying down the methodologies and procedures in conducting economic experiment. According to Smith, every experiment consists of three parts. These parts are; institution, behaviour and environment. Smith went ahead to lay down five crucial requirements for gaining control over the three variables. One the distinctive feature is control. In experimental economics, events are observed in controlled circumstances. These controlled circumstances can be divided into two important features. One is control over a variable that is manipulated by the one doing the experiment and second, control on the background conditions that have been set by the person doing the experiment. The laboratory where the experiment conducted is in some way artificial in comparison to the natural or actual experiment. The main reason for the experiment is to get a clear answer to a scientific question. Different questions can be answered in a laboratory setting but, they depend on certain quantities or variables in a causal relationship in particular. Nowadays it has become a general agreement that experimental method in economics has become to be more than testing theories. (Roth 1995, Smith 1982, 1994, Friedman and Sunder 1994). Originally the development of experimental economics was a result of testing the derived effects of economic theory, ‘gaming’. It was the practice which was common with economic theorists at the time of the emergence of economic experiment. Some experiments of that period were generally made to test the effects of theories like the utility theory of Neumann and Morgenstern and Vernon Smith’s experiments were to test the neoclassical theory in a competitively active market. (Smith 1962). One of the experiments conducted through experimental economics is the public goods theory. This theory states that the lack of property rights over certain types of public goods leads to their low production. The public goods in this case have two characteristics. One, after production, many people can consume it at the same time and two, you cannot make individuals pay for what they take or consume. In the experiment all players anonymously play at the same time. The physical environment where the experiment is to take place must be chosen. It may be a computer room in a university or somewhere else. Consideration must be taken into account of the suitability of a specific environment under which the experiment is to take place. The widely held belief that experimental economics should include incentives is one of the distinctive features of experimental economics. This involves designing incentives in order to motivate subjects in a study. These incentives are believed to get the truth out of the subjects. The only limitation is that it may lead to bias from the subjects. The subjects may be thinking of the maximum amount that they could get out of the particular experiment. The use of money distinguishes experimental economics from other disciplines like psychology. This is because they mostly use university students in the study who are paid a certain amount as incentive for the particular study. Other disciplines may use career professionals in their studies. The capability of a theory to predict is the true measure of success of a certain theory according to Plot. He further emphasizes the importance of using the lab to determine those that do work and those that do not. Edward H. Chamberlin made simple experiments with his students from Harvard by dividing them into two, the sellers and the buyers. By this, he was testing the neoclassical theory on price. Each seller in his experiment was given a different price and every buyer a different price on how to buy. His findings were that the prices were not constant and they fluctuated in a big way. The quantity that was traded was larger than the equilibrium quantity. This might have not been a strong test but was done to reveal that it was not a correct theory. Economic experiment can be used side by side with the traditional method field data collecting model. This can be achieved by testing the various theories in various ways. This is possible because of the laboratory setup offers some kind of control to the experimenter, to do the tests in a low cost environment which exactly fulfill their assumptions. Another advantage is that the setup permits replication which otherwise would not be possible if collecting samples from the field. This is important in the scientific process as it allows the experimenters to have information they would have otherwise not had in the field like for instance, most economic theories are of the opinion that individuals react to their beliefs in specific ways. Beliefs are almost impossible to quantify but can be considered in a laboratory setting.  Laboratory experiments will include one or more of the following objectives. 1. Prediction testing of theories. The laboratory setting can be used to test the accuracy of the prediction made by a particular theory. For instance the equilibrium theory which correctly predicts market prices. The laboratory setting has confirmed this theory which is applicable on a variety of trading organizations. 2. Checking robustness of theories. Laboratory setting can be used to verify the assumptions of theories by weakening those assumptions through testing their predictions. For example, general equilibrium theory makes a prediction on the market prices at the intersection of supply and demand where there are a large number of agents. The work of the laboratory here is to determine this large number assumption. In this aspect the robustness of the theory will be put to test. 3. Using the laboratory setting to test assumptions. Sometimes economists tend to test the assumptions of a particular theory rather than the predictability seeking to put accuracy in the place of the assumption. This is common with behavioral economists seeking to put values to the assumptions. 4. The experiment can be used to determine the consistency of behavior patterns with the theory largely because of the possibility of replication in the laboratory. For example, when using the dictator game, the dictators are supposed to give money to their partner with whom they have been paired. Sometimes these dictators keep the money for themselves The above objectives can be more or less when doing the experiments in a laboratory setting The distinctive contributions this approach has made to the understanding of economic phenomenon While trying to understand the economic phenomenon, this approach has played a big part by testing the theories involved in study of economics. In the modern world, the choice of economic options depends mostly on the politicians who make the choice of the policy that affects the society. To understand this, some aspects must be taken into consideration like the social, political and cultural issues and also the historical precedents. However it is true that other aspects may play a part in policy decisions, focus is on the theory which operates as the invisible hand. This theory is what is tested in a laboratory setting to determine what would happen when the invisible hand is the only determinant. This does not mean that other factors like political and social forces are disregarded. They must be taken into account when applying these theories practically. So, this economic experiment helps us understand these factors with more clarity as we encounter them during the experiments. Economic theories can be used to test the different types of economic theories and therefore make us be informed on the usability and the predictability of a certain theory. These experiments challenge the economic theories to discover the economic phenomena by isolation. The experiments can be used to predict how the changes in the environment can affect the outcomes of the economy. Among the problems that any economy must deal with are what to produce, how and whom to produce for. In trying to deal with these problems, experimental economics have been instrumental in gaining in-depth knowledge in this subject. Experimental economics have given us a better understanding of the problem of scarcity in trying to deal with the question of production. Through price mechanism, scarce resources will be allocated through the market effectively and efficiently under certain conditions. This is well observed through the experimental economics. The economic experiments help us understand well the theories and their applications in the market conditions. New theories come up and it is a sign of scientific development. The economic experiment plays a very important role in development of these theories by determining their usability and predictability. We also learn through such experiments their boundaries within which they should be used. Phenomena have to be discovered and separated from the data. This is done through the laboratory setting because it is possible to control the environment and pick up the forces driving the phenomenon and eventually establishes causality. Other researchers can test the robustness of the phenomenon still in a laboratory setting and how it interacts with the environment. The theories must be able to be applied to simple cases; the laboratory environment can be used to create such a simple case to test a specific theory by creating simple economies. The laboratory setting can be used to test the ability to predict of such a theory. A big number of theories exist and so it is important to test to separate them between those which work and those which do not. (Plott, 1991, p. 902, 905) Critique of this Approach There are several arguments to critique the economic experiment. One of them is that, the experiment that confirmed a theory in the past cannot be used in the future. It means that it does not expressly mean that the outcomes of such an experiment if conducted again will give the same result as it did in the past. (Popper 1934, 1963). This means that the economic experiment is not an outright test of the correctness of a specific theory. The theories have to be simple for the laboratory conditions, the experiments outcomes may not be representative of the natural conditions (Popper, 1934). Despite good confirmations of some economic theories, experimental economics has disapproved also some of the major principles of economic theory making. This is not unexpected from an empirical data, but there has been mixed reactions to the findings which have ranged from varied to conflicting. Some of the researchers have welcomed these shortcomings as a proof that the core principles are flawed relating to economics and they need drastic restructuring. Economic theories are for the natural environments and not for the laboratories. Critiques are of the argument that the results from the experiments cannot be transferred to the real world. Experimental researchers are sometimes annoyed by such critiquing, especially in situations where they cannot differentiate between laboratory and real world and what it amounts to and are made by individuals who not possess a deeper knowledge of laboratory methods. But, when all has been said, the critique pointing to a flaw should not be taken lightly. This experiment makes an assumption that the players in that specific economic environment are two. There are some features of real-life transactions like the auctions that cannot be copied in a laboratory setting. For example the enormous amounts spent for mobile phone licensing. These experiments can go a long way towards mimicking the features of the target data for the experiment. Other situations like tax evasion are hard to investigate in laboratory setting because those involved in such a vice tend to behave differently with the target phenomenon. Among the criticism of this method is that because is conducted by students, they have no capability of making informed decision because they do not possess the underlying knowledge of the theories. This knowledge is important when conducting the experiments. Its critique of neoclassical economics Neoclassical economics emerged as early as around 1870 which involved formulation of economics laws that were accurate. This laws were based on production, distribution and eventual consumption using the theory of optimization through cost and benefit calculation. One of the critiques to this theory is that the game theory does not give real examples with real data from the observed facts like in the economic experiment. This neoclassical theory underscores the importance of giving attention to behavioral and other forces in the real market environment. The mathematician Keynes noted that this approach of using mathematical equations was not bearing fruits in this aspect. Neoclassical approach is criticized for falling on the normative economic approach, meaning it is not flexible enough to be used in the actual economy. In the opinion of some of the critiques is that it was designed for the perfect society and this does not exist in the real world of economics. It is used in optimum levels which are most often not always attainable (Eichner, et al, 1975, pg. 1293). The connection between the growth of the economy and income distribution is not taken into account by this model of neoclassical economics. They are instead modelled on the behaviours of the people. Moreover, another problem of this model is that its boundaries are unclear, since it is based on the behaviours of individuals. Behaviours of individuals are not always constant and cannot usually be measured effectively (Trigg, et al, 2002, pg. 4) One of the greatest challenges that the neoclassical theory experienced was during the US depression of 1929. The theory advocated a cut in wages so the costs could be reduced and in the process increase profits. This, according to theory would revive the economy through the stimulation of business. This eventually never happened but made the depression even more badly off. This lead to rethinking of using the theory since its usage did not solve the problems for which it was intended in the first place. Neoclassical economics had failed to answer the question of what makes the economies to grow. Static equilibrium resources allocation could not answer this question. Economists tried to come up with empirical evidence like those published by Angus Maddison where they pointed at several factors that lead to economic growth. Among those factors that the economists came up with was the “Harrod Domar Model”. Neo classical economics had failed to use some of the measurements that are used in experimental economics to determine what made the economies grow. The behavior of an individual is influenced by a number of factors and their decisions are not always rational. Also, a competitive market which is perfect does not in real sense exist in the real world market. Neoclassical economics had no provision for these factors. Another factor not taken into consideration is that comparison of marginal costs with revenue is not a decision factor taken by businesses in the real world. There are no perfect factors of production and divisibility of labor. Neoclassical economics focusing on costs of transactions largely ignore the fact that businesses are run by several people. The model makes the assumption that it is run by a single individual who makes all the decisions of the business. In this way the model simply lacks credibility (Boldeman, 2007). The neoclassical economics model is critiqued for its high reliance on the mathematical calculations like those used in the general equilibrium calculation which are complex, while taking little account whether they explain the real economic situation. The main criticism of the neoclassicism has been the failure of the model to explain production process through its theory. Works Cited Pheby, John. New Directions in Post-Keynesian Economics. Aldershot, Hants, England: E. Elgar, 1989. Print. Alfred S. Eichner and J. A. Kregel, An Essay on Post-Keynesian Theory: A New Paradigm in Economics, Journal of Economic Literature, V. 13, N. 4 (Dec.): pp. 1293-1314. 1975 Trigg, Andrew, Susan Himmelweit, and Roberto Simonetti. Microeconomics: Neoclassical and Institutionalist Perspectives on Economic Behaviour. London: Thomson, 2002. Print. Wettersten, John. How Do Institutions Steer Events?: An Inquiry into the Limits and Possibilities of Rational Thought and Action. Aldershot [u.a.: Ashgate, 2006. Print. Boldeman, Lee. The Cult of the Market: Economic Fundamentalism and Its Discontents. Canberra, ACT, Australia: ANU E Press, 2007. Internet resource. Popper, K, Logik der Forschung, Wien: Springer Verlag. 1934 Popper, K., Conjectures and Refutations, London: Routledge 1963 Davis, Douglas D, and Charles A. Holt. Experimental Economics. Princeton, N.J: Princeton University Press, 1992. Print. Plott, C, Will Economics Become an Experimental Science?” Southern Economic Journal, 1991, Vol. 57, 901-19. James K. Galbraith, A contribution on the state of economics in France and the world. Post-autistic economics newsletter: 2001, issue no. 4, January, article 1 Weeks, John. A Critique of Neoclassical Macroeconomics. Houndmills, Basingstoke, Hampshire: Macmillan, 1989. Print. The Death of Economics by Paul Ormerod, John Wiley & Sons Inc., New York, 1997. A Guide to What’s Wrong with Economics, edited by Edward Fullbrook, Anthem Press, 2005. The Soulful Science: What Economists Really Do and Why it Matters by Diane Coyle, Princeton University Press, 2007. Read More