Empirical and Experimental Industrial Organization

1 Introduction

This seminar aims to improve students’ understanding of strategic decision-making by firms. We will study the strategic aspects of various competitive situations and the behavior of firms in those situations. We will confront predictions from models of strategic interaction with how actors really behave in the modeled situations. In doing so, we will rely on data from laboratory and field experiments as well as empirical studies.

More specifically, we will study market competition and collusion, auctions and other methods of price formation, and models of adaptation and learning in games. We will in particular consider how limits in the rationality of the decisions of consumers and firms affect the strategy of firms in those situations.

At the end of the seminar, students will be able to identify managerial decisions that involve strategic considerations. They will know how to model those decisions in the context of a game. They will have learned how to compare predictions from game theoretical models with empirical and experimental data.

2 Organization of the course and grading

The seminar will take place as a block seminar on the 8th and 9th of June from 14.00 to 18.00 on both days. You will be advised of the room number in time.

2.1 Choosing an article

Students will choose from a list of academic articles in the field of experimental and empirical industrial organization. Each participant will choose one of those articles at the beginning of the semester and prepare a presentation.

The deadline for sending me your choice of article is on the 8th of April. After that date, those who did not make a choice will be assigned an article by me.

Assignment of articles to students is on a first-come, first-served basis. This means that students may be asked to choose an article other than their first choice if another student already chose it or if the paper category is already well covered (i.e. two students already chose a paper in that category).

Students may ask to present an article that is not in the list below (but within the categories below), but only if they can argue that the topic of their preferred article is not covered in the list below. A student may not present an article outside of the list below without approval of the seminar leader.

2.2 Presentation

Students will present their article at the end of the semester to others along the following lines:

  1. Motivation of the article (why the research is important and interesting).
  2. Overview of related experimental and empirical literature.
  3. Description of the empirical study or experimental design.
  4. Summary and explanation of the findings.
  5. Discussion, including assessment of the credibility and applicability of the results.

2.3 Essay

Students will then deliver an essay about their chosen academic article, which they will submit about two weeks after their presentation. The essay will therefore take into account discussion and input by others after their presentation. In writing the essay, please follow general instructions here: https://www.kirchkamp.de/seminarxx/indexEN.html.

2.4 Grading

  • The presentation (ca. 30 minutes + 15 minutes discussion) will count for 50% of the grade.
  • The essay (max. 10 pages) will count for the other 50% of the grade.
  • Presence and participation during the presentations of other students is mandatory.

3 References

The following books may be used as references for the understanding of standard and less traditional models of strategic behavior, as well as to understand the methods of experimental economics.

  1. Tirole, Jean. 1988. The Theory of Industrial Organization. MIT Press. (for models of strategic interaction)
  2. Spiegler, Ran. 2011. Bounded Rationality and Industrial Organization. Oxford University Press. (for models with boundedly rational economic agents).

The following articles are also useful:

  1. Plott, Charles R., 1982. Industrial Organization Theory and Experimental Economics, Journal of Economic Literature, 20(4), 1485-1527. http://www.jstor.org/stable/2724830
  2. Normann, H.-T., Ricciuti, R., 2009. Laboratory Experiments for Economic Policy Making. Journal of Economic Surveys 23, 407–432. http://onlinelibrary.wiley.com/doi/10.1111/j.1467-6419.2008.00567.x/abstract
  3. Armstrong, M., Huck, S., 2010. Behavioral economics as applied to firms: a primer, MPRA Paper No. 20356. https://ideas.repec.org/p/pra/mprapa/20356.html
  4. Einav, L., & Levin, J., 2010. Empirical industrial organization: A progress report. Journal of Economic Perspectives, 24(2), 145-62. http://www.aeaweb.org/articles?id=10.1257/jep.24.2.145

4 List of articles

Articles to be presented belong to several categories corresponding to the following subsections.

4.1 Competitive markets

General equilibrium theory is one of the crowning achievements of economics, but relies on rather implausible assumptions about perfect information, immediate price adjustments, or rational economic agents. However, experiments have shown that those assumptions are not necessary in practice: markets seem to converge to competitive equilibria under a surprisingly large range of conditions.

  1. Chamberlin, Edward H., 1948. An Experimental Imperfect Market, Journal of Political Economy, 56(2), 95-108. http://www.jstor.org/stable/1826387
  2. Smith, Vernon L., 1962. An Experimental Study of Competitive Market Behavior, Journal of Political Economy, 70, 111-37. http://www.jstor.org/stable/1861810
  3. Joyce, P., 1983. Information and behavior in experimental markets, Journal of Economic Behavior and Organization, 4, 411-424. http://www.sciencedirect.com/science/article/pii/0167268183900173
  4. Holt, Charles A. 1985. “An Experimental Test of the Consistent-Conjectures Hypothesis.” The American Economic Review 75 (3): 314–25. http://www.jstor.org/stable/1814802
  5. Roth, A.E., Prasnikar, V., Okuno-Fujiwara, M., Zamir, S., 1991. Bargaining and market behavior in Jerusalem, Ljubljana, Pittsburgh, and Tokyo: An experimental study. The American Economic Review, 81(5), 1068–1095. http://www.jstor.org/stable/2006907
  6. Kirchsteiger, G., Niederle, M., Potters, J., 2005. Endogenizing market institutions: An experimental approach. European Economic Review 49, 1827–1853. http://www.sciencedirect.com/science/article/pii/S0014292104000650

4.2 Asset markets

Prices in asset market are supposed to correspond to the net present value of the underlying commodity. There should therefore be no bubbles, that is, long term deviations from this. This leads economists to be very critical of any talk of bubbles, for example in the stock market, in housing, and in currencies, such as bitcoins. Experimentalist have therefore repeatedly shown that bubbles can arise naturally in experimental markets; they explore conditions for this to happen.

  1. Forsythe, Robert, Thomas R. Palfrey, and Charles R. Plott. 1982. Asset Valuation in an Experimental Market. Econometrica 50 (3): 537–67. http://www.jstor.org/stable/1912600
  2. Smith, Vernon L., Gerry L. Suchanek, and Arlington W. Williams, 1988. Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets. Econometrica 56(5), 1119–51. http://www.jstor.org/stable/1911361
  3. Lei, V., Noussair, C. N., & Plott, C. R., 2001. Nonspeculative Bubbles in Experimental Asset Markets: Lack of Common Knowledge of Rationality vs. Actual Irrationality. Econometrica, 69(4), 831–859. http://www.jstor.org/stable/2692246
  4. Dufwenberg, M., Lindqvist, T., & Moore, E., 2005. Bubbles and Experience: An Experiment. The American Economic Review, 95(5), 1731–1737. http://www.jstor.org/stable/4132775
  5. Stöckl, T., Huber, J., & Kirchler, M., 2010. Bubble measures in experimental asset markets. Experimental Economics, 13(3), 284-298. https://doi.org/10.1007/s10683-010-9241-9

4.3 Auctions

The main lesson from auction theory is that auction design should not matter that much. Indeed, under the revenue equivalence theorem (reference), expected revenue for the auctioneer does not depend on how the auction is going to be run. However, this holds only under specific conditions. In practice, there might be collusion between bidders, a winner’s curse due to limited rationality on the part of bidders, too little participation in auctions due to predatory behavior, etc… Experimentalists have therefore explored how such issues arise and can be moderated.

  1. Thaler, R. H. (1988). Anomalies: The winner’s curse. Journal of Economic Perspectives, 2(1), 191-202. http://www.aeaweb.org/articles?id=10.1257/jep.2.1.191
  2. (field experiment) Lucking-Reiley, David., 1999. Using Field Experiments to Test Equivalence between Auction Formats: Magic on the Internet. American Economic Review, 89(5) 1063-1080. http://pubs.aeaweb.org/doi/abs/10.1257/aer.89.5.1063
  3. (field experiment) Hossain, T., & Morgan, J., 2006. … plus shipping and handling: Revenue (non) equivalence in field experiments on ebay. Advances in Economic Analysis & Policy, 5(2). https://doi.org/10.2202/1538-0637.1429
  4. Filiz-Ozbay, Emel, and Erkut Y Ozbay. 2007. Auctions with Anticipated Regret: Theory and Experiment. American Economic Review 97(4): 1407–18. http://pubs.aeaweb.org/doi/abs/10.1257/aer.97.4.1407
  5. Kirchkamp, O., Poen, E., & Reiß, J. P., 2009. Outside options: Another reason to choose the first-price auction. European Economic Review, 53(2), 153–169. https://doi.org/10.1016/j.euroecorev.2008.03.005
  6. (empirical) Ashenfelter, O., & Genesove, D., 1992. Testing for Price Anomalies in Real-Estate Auctions. The American Economic Review, 82(2), 501–505. https://www.jstor.org/stable/2117452

4.4 Collusion and other anti-competitive behavior

As with bubbles, the idea that firms may collude is controversial in economics, and very difficult to prove in practice. Experimentalists have therefore explored how likely it is that collusion may establish itself, and how it may be discouraged by for example increasing the number of firms in the market or imposing fines on colluders.

  1. Dolbear, F. Trenery, Lester B. Lave, G. Bowman, A. Lieberman, E. Prescott, F. Rueter, and Roger Sherman, 1968. Collusion in Oligopoly: An Experiment on the Effect of Numbers and Information. The Quarterly Journal of Economics, 82(2), 240-59. http://www.jstor.org/stable/1885896
  2. Huck, S., Müller, W., Normann, H.-T., 2001. Stackelberg Beats Cournot: On Collusion and Efficiency in Experimental Markets, Economic Journal, 111, 749–765. http://www.jstor.org/stable/798411
  3. Huck, S., Normann, H.-T., Oechssler, J., 2004. Two Are Few and Four Are Many: Number Effects in Experimental Oligopolies, Journal of Economic Behavior & Organization, 53, 435–446. https://doi.org/10.1016/j.jebo.2002.10.002
  4. Huck, S., Konrad, K.A., Müller, W., Normann, H.-T., 2007. The Merger Paradox and why Aspiration Levels Let it Fail in the Laboratory. The Economic Journal 117, 1073–1095. http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0297.2007.02067.x/abstract
  5. Bigoni, M., Fridolfsson, S.-O., Le Coq, C. and Spagnolo, G., 2012. Fines, leniency, and rewards in antitrust. The RAND Journal of Economics, 43, 368–390. http://onlinelibrary.wiley.com/doi/10.1111/j.1756-2171.2012.00170.x/abstract
  6. (empirical) West, D. S., & Hohenbalken, B. V., 1984. Spatial Predation in a Canadian Retail Oligopoly. Journal of Regional Science, 24(3), 415–427. https://doi.org/10.1111/j.1467-9787.1984.tb00812.x

4.5 Adverse selection

Theories of market behavior generally assume perfect information, but many markets are characterized by the presence of significant asymmetric information. As shown by Akerlof, such markets may “unravel”, that is, no one is ready to trade because they do not trust their counterpart. Real markets where such issues should arise do exist however. This is because there are ways out of this issue if firms can credibly signal their quality to consumers, or if other mechanisms are used, such as offering guarantees to consumers, building reputations or getting goods certified through intermediaries.

  1. Miller, Ross M. and Charles R. Plott, 1985. Product Quality Signaling in Experimental Markets, Econometrica, 53, 837-72. http://www.jstor.org/stable/1912657
  2. Dejong, D. V., Forsythe, R., & Lundholm, R. J., 1985. Ripoffs, lemons, and reputation formation in agency relationships: A laboratory market study. The Journal of Finance, 40(3), 809-820. https://doi.org/10.1111/j.1540-6261.1985.tb05006.x
  3. Bester, H., 1993. Bargaining versus price competition in markets with quality uncertainty. The American Economic Review, 83(1), 278–288. http://www.jstor.org/stable/2117511
  4. Bolton, G. E., Katok, E., & Ockenfels, A., 2004. How Effective Are Electronic Reputation Mechanisms? An Experimental Investigation. Management Science, 50(11), 1587–1602. https://doi.org/10.1287/mnsc.1030.0199
  5. (empirical) Mavlanova, T., Benbunan-Fich, R., & Koufaris, M., 2012. Signaling theory and information asymmetry in online commerce. Information & Management, 49(5), 240–247. https://doi.org/10.1016/j.im.2012.05.004

4.6 Moral hazard

In markets with asymmetric information, it is difficult to monitor not only the quality of products offered by firms (see section on reputation and signaling), but also the effort exerted by others in delivering services. This is an issue in collective decision problems, such as in the management of public goods, and in the relation between clients and service providers, such as financial advisers or health professionals. Does this mean that there will be underprovision of effort? How can people be disciplined into delivering adequate service when the client is unable to judge of its quality?

  1. (empirical) Lin, J., 1990. Collectivization and China’s Agricultural Crisis in 1959-1961. Journal of Political Economy, 98(6), 1228-1252. http://www.jstor.org/stable/2937756
  2. (empirical) Dunham, W. R., 2003. Moral hazard and the market for used automobiles. Review of Industrial Organization, 23(1), 65-83. https://doi.org/10.1023/B:REIO.0000005630.49071.4a
  3. Angelova, V., & Regner, T., 2013. Do voluntary payments to advisors improve the quality of financial advice? An experimental deception game. Journal of Economic Behavior & Organization, 93, 205–218. https://doi.org/10.1016/j.jebo.2013.03.022
  4. Danilov, A., Biemann, T., Kring, T., & Sliwka, D., 2013. The dark side of team incentives: Experimental evidence on advice quality from financial service professionals. Journal of Economic Behavior & Organization, 93, 266–272. https://doi.org/10.1016/j.jebo.2013.03.012
  5. Mimra, W., Rasch, A., & Waibel, C., 2016. Price competition and reputation in credence goods markets: Experimental evidence. Games and Economic Behavior, 100, 337–352. https://doi.org/10.1016/j.geb.2016.09.012

4.7 Confused consumers and exploitative firms

This section extends previous sections that dealt with asymmetric information in markets and under-provision of effort by service providers. A way out is often to invoke that, as long as some consumers are informed, then firms will be disciplined into providing adequate quality and level of services. Is this the case empirically? Can firms find ways to satisfy informed consumers while still exploited those who are uninformed?

  1. (empirical) Wong, H. S., 1996. Market structure and the role of consumer information in the physician services industry: An empirical test. Journal of Health Economics, 15(2), 139–160. https://doi.org/10.1016/0167-6296(95)00035-6
  2. (empirical) Turnbull, P. W., Leek, S., & Ying, G., 2000. Customer Confusion: The Mobile Phone Market. Journal of Marketing Management, 16(1–3), 143–163. https://doi.org/10.1362/026725700785100523
  3. Morgan, John, Henrik Orzen, and Martin Sefton, 2006. An Experimental Study of Price Dispersion. Games and Economic Behavior, 54(1), 134-58. http://www.sciencedirect.com/science/article/pii/S0899825605000588
  4. (empirical) Woodward, S. E., & Hall, R. E. (2010). Consumer Confusion in the Mortgage Market: Evidence of Less than a Perfectly Transparent and Competitive Market. American Economic Review, 100(2), 511–515. https://doi.org/10.1257/aer.100.2.511
  5. Kenan Kalayci and Jan Potters, 2011. Buyer Confusion and Market Prices, International Journal of Industrial Organization, 29(1), 14-22. http://linkinghub.elsevier.com/retrieve/pii/S0167718710000949
  6. Crosetto, P., & Gaudeul, A. (2017). Choosing not to compete: Can firms maintain high prices by confusing consumers? Journal of Economics & Management Strategy, 26(4), 897–922. https://doi.org/10.1111/jems.12212

4.8 Imitation and learning

When modeling behavior in games, we often assume that participants know the rules of the game and their payoffs, and are able to predict the behavior of their counterpart. This is not the case in reality however. How do participants in games learn those rules and adapt to the behavior of other participants, in particular when other participants are not fully rational? Does the outcome of such a learning process lead to the same outcome as if there was perfect information right at the beginning?

  1. Huck, Steffen, Hans-Theo Normann, and Jörg Oechssler, 1999. Learning in Cournot Oligopoly – An Experiment. The Economic Journal 109(454), C80–95. http://www.jstor.org/stable/2565908
  2. Theo Offerman, Jan Potters and Joep Sonnemans, 2002. Imitation and belief learning in an oligopoly experiment, Review of Economics Studies, 69(4), 973-997 http://restud.oxfordjournals.org/content/69/4/973.short
  3. Selten, R., Apesteguia, J., 2005. Experimentally observed imitation and cooperation in price competition on the circle. Games and Economic Behavior, 51, 171–192. http://www.sciencedirect.com/science/article/pii/S0899825604000697
  4. Altavilla, C., Luini, L., & Sbriglia, P., 2006. Social learning in market games. Journal of Economic Behavior & Organization, 61(4), 632-652. https://doi.org/10.1016/j.jebo.2004.07.012
  5. Friedman, D., Huck, S., Oprea, R., & Weidenholzer, S., 2015. From imitation to collusion: Long-run learning in a low-information environment. Journal of Economic Theory, 155, 185–205. https://doi.org/10.1016/j.jet.2014.10.006

4.9 Fairness concerns

Economists generally assume that economic agents are egoistic decision makers, that is, they take only their own interests into account when making their decisions. This is a very useful simplification of reality, and it can lead to very efficient results. Real life is a bit different however, since individuals follow norms of behavior that condemn purely egoistic behavior. Furthermore, they compare their payoffs to others and dislike being exposed to inequality and discrimination. How does this affect the functioning of markets?

  1. Kahneman, Daniel, Jack L. Knetsch, and Richard Thaler. 1986. Fairness as a Constraint on Profit Seeking: Entitlements in the Market. The American Economic Review, 76(4), 728–41. http://www.jstor.org/stable/1806070
  2. Fehr, E., Kirchsteiger, G., & Riedl, A., 1993. Does Fairness Prevent Market Clearing? An Experimental Investigation. The Quarterly Journal of Economics, 108(2), 437–459. https://doi.org/10.2307/2118338
  3. Huck, S., Normann, H. T., & Oechssler, J., 2001. Market volatility and inequality in earnings: experimental evidence. Economics Letters, 70(3), 363-368. https://doi.org/10.1016/S0165-1765(00)00391-8
  4. Richards, T. J., Liaukonyte, J., & Streletskaya, N. A., 2016. Personalized pricing and price fairness. International Journal of Industrial Organization, 44, 138-153. https://doi.org/10.1016/j.ijindorg.2015.11.004
  5. (field experiment) Toler, S., Briggeman, B. C., Lusk, J. L., & Adams, D. C., 2009. Fairness, farmers markets, and local production. American Journal of Agricultural Economics, 91(5), 1272-1278. https://doi.org/10.1111/j.1467-8276.2009.01296.x