Donhatai Harris dh293@cam.ac.uk Cambridge Experimental &Behavioural Research Group (CEBEG)

1. An Introduction to Experimental Economics: How to gain an insight into human's behaviour and decisions Donhatai Harris dh293@cam.ac.uk Cambridge Experimental &Behavioural Research Group (CEBEG) Faculty of Economics University of Cambridge, UK

2. Outline of Today’s Lecture • Why Experiment? • What is experimental economics? • How to conduct an experiment: Key Principles of experimental economics • Previous experiment work in Thailand (Harris et al., 2008) • Key contributions of Experimental Economics to Economics Discipline and Future Challenges. Donhatai Harris

3. I. Why experiment? Donhatai Harris

4. I. Why experiment? • Economics has been regarded as a non-experimental science, where researchers – as in astronomy or meteorology – have had to rely exclusively on field data, that is, direct observations of the real world. • The lack of experimental data meant that when an economic proposition appeared not to be captured by the data or the outcome was not as predicted by the theory, the quality of the data was more likely to be questioned than the relevance or quality of the theory But the theory may not always be correct, particularly in predicting human behaviour! Donhatai Harris

5. II. What is Experimental Economics? Objectives of Economic Experiments • Testing theories • Establish empirical regularities as a basis for new theories • Testing institutions • Studying preferences and decision-making • Goods (public goods), risk, fairness, time preference • Replication of previous work • Teaching economics Donhatai Harris

6. II. What is experimental economics? Donhatai Harris

7. II. What is Experimental Economics? Experimental economics is an empirical tool that enables economists to understand the extent to which an individual’s decision and behaviour are affected by various (testable) factors in a controlled environment. Donhatai Harris

8. II. What is Experimental Economics? • To establish whether an independent variable influences the dependent variable (outcome) “treatment effect”  need to establish counter-factual. • Controlled experiments represent the most convincing method of creating the counterfactual, since they directly construct a control group via randomization. Donhatai Harris

9. I. Why experiment? An example: Theory:Sub-game perfect equilibrium (Selten, 1965) Experiment:A simple bargaining game with 2 players (Guth, Schmittberger and Schwarze, 1982): • Player 1 makes a proposal for how a sum of money is to be split between players 1 and 2. • Player 2 then either accepts, implementing the proposal, or rejects, in which case the interaction ends with zero payoffs for each. What is SPE? & What do you think happens in the experiment? Donhatai Harris

10. II. What is Experimental Economics? The result show… • A marked contrast between theory and experiment • But why should we be interested in this result? • Is the experimental environment sufficiently close to the situation of interest to be informative? Rather..we should ask • How special is the laboratory environment generating the experimental results? • Is it just one result? Can it be replicated? Is it robust? Donhatai Harris

11. II. What is Experimental Economics? • The body of experimental evidence suggests that our simplest theories of bargaining leave some aspects of behaviour unexplained. • The importance of reciprocity and fairness concerns Theory of Inequity Aversion Preference (Fehr and Schmidt, “A Theory of Fairness, Competition, and Cooperation”, Quarterly Journal of Economic, 1999) “In addition to selfish individuals, there are people who dislike outcomes that are perceived as inequitable.” Donhatai Harris

12. II. What is Experimental Economics? The model is centred around a utility function that involves one's own payoff and the payoff of one's opponent, and that exhibits some aversion to payoff inequality. The second term in (1)or (2) measures the utility loss from disadvantageous inequality, while the third term measures the loss from advantageous inequality. Donhatai Harris

13. II. What is Experimental Economics? Typology of economic experiments (Harrison & List, Journal of Economic Literature 2004) • Conventional lab experiment • Standard subject pool of students • Abstract framing • Imposed set of rules • Artefactual field experiment • Like a conventional lab experiment but with a non-standard (i.e., non-student) subject pool • Framed field experiment • same as an artefactual field experiment, but with field context in either the commodity, task, or information set that the subjects can use • Natural Field Experiment • same as a framed field experiment but where the environment is one where the subjects naturally undertake these tasks and where the subjects do not know that they are in an experiment. Donhatai Harris

14. II. What is Experimental Economics? Sources of empirical data Donhatai Harris

15. III. How to conduct a laboratory experiment Donhatai Harris

16. III. How to conduct an experiment? Key principles (Smith, 1982; 1994) • In laboratory experiment, a microeconomic system is created which reflects a complete and self-contained economy. • Two important components: (i) Environment: • Economic agents with Preferences, technology, and initial endowments • Controlled by using monetary rewards (ii) Institution (rules of the game): • Possible actions • Sequence of actions • Information conditions • Framing (language, story) Donhatai Harris

17. III. How to conduct an experiment? The Essence of Economic Experiments • Experimenter knows what is exogenous and endogenous. • Experimenter controls information conditions. • Experimenter knows the theoretical equilibrium and adjustment can be studied. • Evidence is replicable. Donhatai Harris

18. III. How to conduct an experiment? Control • To control a variable means fixing and maintaining it at some constant level, or alternatively, set it at different levels across different experiments or at different points of time in the same experiments. • The subjects are likely to have prior characteristics and preferences which are difficult to observe. Therefore, control over preferences is the most significant element of laboratory experiments. • In many experiments the experimenter wants to control subjects’ preferences. How can this be achieved? Donhatai Harris

19. III. How to conduct an experiment? Theory of Induced Valuation • Subjects’ “homegrown” preferences must be “neutralized” and the experimenter “induces” new preferences. Subjects’ actions should be driven by the induced preferences. • This is done by inducing or controlling valuations by making the objects of trade = valueless tokens, which can be exchanged into real money at the end of the experiment. Donhatai Harris

20. III. How to conduct an experiment? • Reward Medium: Money m = (m0 + m) where m0 represents a subject’s “outside” money, m denotes money earnings in the experiment. • Subject’s unobservable preference: V(m0 + m, z) where z represents all other motives e.g. boredom • In order to minimise the effects of m0 and z, whilst maximise the effect of m,laboratory experiments are required to satisfy 5 important conditions which are known as “precepts” Donhatai Harris

21. III. How to conduct an experiment? Precepts • Precept 1: Nonsatiation and Monotonicity Costless choice between two alternatives, identical (i.e. equivalent) except that the first yields more of a reward medium than the second, the first will always be chosen (i.e. preferred) over the second, by an autonomous individual • Precept 2: Saliency such rewards must be associated indirectly with the message actions (or decisions) of experimental subjects and that they understand this relation Donhatai Harris

22. III. How to conduct an experiment? • Precept 3: Dominance The reward structure dominates any subjective costs (or values) associated with participation in the activities of an experiment. • Precept 4: Privacy Each subject in an experiment is given information only on his/her own payoff alternatives. • Precept 5: Parallelism The behaviour of individuals and the performance of institutions that have been tested in laboratory microeconomies also apply to non-laboratory microeconomies where similar cateris paribus conditions hold

23. III. How to conduct an experiment? Experimental Design and Procedure 1) Phases of Economic Experiment • preliminary phase (experimental design) • pilot experiment • exploratory experiment (actual experiment) • follow-up experiments Donhatai Harris

24. III. How to conduct an experiment? 2) Human Subjects • Student: convenient, low opportunity cost. • Non-student: increases parallelism, but high opportunity cost, risk of unknown confounds. (Minimum of 30 independent observations and Always invite 20% more than you need) Recruiting the subjects is key! • Manual recruitment • computer-assisted recruitment Donhatai Harris

25. Recruiting the subjects Centre for Research in Microeconomics [CReMic]

26. Centre for Research in Microeconomics [CReMic]

27. Experiment session will appear here Centre for Research in Microeconomics [CReMic]

28. Centre for Research in Microeconomics [CReMic]

29. III. How to conduct an experiment? 3) Experimental Design • Focus variable(s)  Treatment • Other variables (Nuisances)  controlled • between-subject vs. within-subject designs • ‘session’ = a unit of experiment. An experiment can have many sessions. Donhatai Harris

30. III. How to conduct an experiment? 4) Instructions, Framing, and Anonymity • Instructions tells subjects what they are asked to do in the experiment • Framing: The way in which the instruction is worded can be distinguished into ‘neutral’ or ‘loaded’ frames. • Anonymity Donhatai Harris

31. III. How to conduct an experiment? 5) Conducting an Experiment • A step-by-step procedure • Set up the lab: What Does a Lab Experiment Look Like? Computerised experiment Pen & paper experiment Donhatai Harris

32. III. How to conduct an experiment? Registration • Print a list of subjects for that session for registration

33. III. How to conduct an experiment? Start the experiment • Welcome statement • Prepare lab IDs for randomisation • If more people turn up than needed: (1) Ask for volunteer to leave and get the show-up fee (2) If not volunteer, do a random draw (prepare lab IDs for randomisation with some blank ones) Donhatai Harris

34. III. How to conduct an experiment? During the experiment • Each participant is asked to pick a computer lab ID which corresponds to their seats in the lab. The participants then enter the lab one-by-one. • The Silent rule: once entered the lab, the participants are not allowed to communicate to each other (in order to ensure that they make the decision individually and privately) and are seated behind a partition. Donhatai Harris

35. http://www.iew.uzh.ch/ztree/index.php Centre for Research in Microeconomics [CReMic]

36. http://www.iew.uzh.ch/ztree/index.php Z-tree Z-leaf Z-leaf Z-leaf Z-leaf Z-leaf Donhatai Harris

37. III. How to conduct an experiment? z-Tree: basic concepts • Subjects enter input into screens. Output (parameters, results etc.) also shown on screens. • Subjects navigate through different screens in z-Leaf as they move through “stages” in z-Tree. • Experimenter controls the experiment through z-Tree and can monitor what the subjects are doing. Donhatai Harris

38. III. How to conduct an experiment? • Post-experimental questionnaire • Negative Payments or Bankruptcy • Data Recording and Analysis • qualitative or descriptive phase • quantitative analysis of treatment effect i.e. ‘does treatment X affect outcome Y?’ Donhatai Harris

39. III. How to conduct an experiment? Internal and external validity • Internal validity: Do the data permit causal inferences? Internal validity is a matter of proper experimental controls, experimental design, and data analysis. • External validity: Can we generalize our inferences from the laboratory to the field? Donhatai Harris

40. IV. Experimental Study of Favouritism: Thailand vs. UK Donhatai Harris

41. The Impact of Social Norms on Favouritism Behaviour Donna Harris University of Cambridge dh293@cam.ac.uk With Benedikt Herrmann (Nottingham) and Andreas Kontoleon (Cambridge)

42. I. Definition & Research Question • Definition: Favouritism = Preferential treatment giving to one person or group at the expense of another. • Broad research questions: 1) If favouritism creates Pareto inferior outcome, why is it still observed in many countries around the world? 2) Why do we observe varying degrees of favouritism across countries? What is the role of social norms in determining the level of favouritism within a given society?

43. II. Related Literature • Literature on Favouritism: Previous studies have not explained ‘why’ different levels of favouritism are observed in different countries– most have focused on the ‘effects’ of favouritism. • Social Norms & Enforcement Mechanisms: Most previous studies have only focused on one type of norm, such as the norm of cooperation, or one social group and the enforcement of social norm within that group, except for Bernhard et al. (2006); Goette et al. (2006); Gaechter and Herrmann, 2007; Herrmann et al. (2008).

44. Specific Research Questions • What is the social norm regarding favouritism? • Can the prevalence of a particular norm regarding favouritism lead to different levels of favouritism across countries? • The norm which is prevalent  strongly enforced by different social groups within a society. • Can different social groups follow different social norms? In-group bias vs. egalitarianism vs. Out-group Bias Norms

45. IV. Experimental Design Allocation Game (Favour game) 7 players, 1 decision-maker, 3 in-group members & 3 out-group members. T0: No punishment (baseline) T1: Only the ‘in-group’ members are allowed to punish (cost: punish = 1: 5) T2: Only the ‘out-group’ members are allowed to punish (cost: punish=1:5) T3: Only an independent ‘third-party’ is allowed to punish (cost: punish=1:3)

46. The Choice set: Control for allocation space Out-group Favouritism Anti-social preference In-group Favouritism Generalised Inequity Aversion Each member of YOUR group Each member of the OTHER group

47. Result 1: In-Group Punishment The threat of in-group punishment increasesfavouritism in Thailandbut does not have the same effect in the UK.

48. Result 2: In-group Punishment Behaviour 75% chose not to punish 92% chose not to punish In Thailand, on average the other in-group members punished the decision-makers the most when they choose option B and D, while in the UK options C and D get punished the most.

49. Result 3: Out-group Punishment The threat of out-group punishment reducesfavouritism and shifts the allocation decisions towards equitable outcome in the UK, but not in Thailand.

50. Result 4: Out-group Punishment Behaviour 48% chose not to punish 61% chose not to punish In Thailand, on average the out-group members punished the decision-makers the most when they chose option B , whilst in the UK options A and B were punished the hardest.