Earlier in this course you saw how the supply curve and the demand curve could predict the market price for a product and the quantity of the product that will be bought and sold. But you may be wondering, is that prediction correct? Does the model really work?
One way to show that the model does work is to conduct an experiment, to observe how buyers and sellers behave under market conditions. John Taylor and Toby Page are doing that with this group of economics students. how markets work.
And the experiment's going to be called a double oral auction, where you're going to be both buying and selling things. There's going to be buyers... In the ordinary auctions you're used to seeing, only the buyers call out prices. The buyer who makes the highest bid gets the item.
In a double auction, both the buyers and the sellers call out prices. Buyers bid a certain price for items they want to buy, and sellers ask a certain price for items they want to sell. When a buyer and seller agree on a price, a sale takes place. takes place. This is how stock and commodities exchanges usually work.
For this experimental auction to resemble a real auction, the buyers and sellers must be motivated to make the best deals they can. The rules here is to keep your private information private. Each buyer has been given an information sheet containing a marginal benefit table.
Each buyer's marginal benefit is different, just as each buyer's circumstances are different in the real world. None of the buyers can see the other buyers' tables. According to this buyer's table, she'll receive a $5.39 marginal benefit for the first item she buys, a $4.90 marginal benefit for the second item she buys, and a $3.10 marginal benefit for the third item she buys. Of course, her actual reward for the transaction is the amount of her marginal benefit minus the amount she pays for the item. So if she buys the first item for $5, her net gain is $1.
gain is 39 cents. Obviously then, there is no reason for her to pay more than $5.38 for the item. Similarly, each seller has a different table listing the marginal cost for each item sold. The sellers in the experiment can't see the other sellers' tables as you can.
According to this seller's table, his marginal cost is $1.47 for the first item he sells, $3.08 for the second item he sells. and $5.05 for the third item he sells. So, for example, if he sells the first item for $5, his net gain is $3.53. And, of course, there's no reason for him to sell the item for anything less than $1.48.
To indicate whether you want to bid, it would be nice if you could raise your hand. I'm the auctioneer, and it will help me see you if you raise your hand if you want to bid or if you want to, as a seller, you want to ask something for your product. If you really want to accept someone else's bid, asks for a buyer wants to accept an ask raise two hands and then I'll determine whether it was you or you that actually made the acceptance and what Toby will do is write down as the process goes the bids and asks and when there's an acceptance you'll circle it and that'll indicate a transaction's actually been made.
Before the auction begins, let's see whether we can predict the most likely outcome. This chart represents the supply curve for the seller's table you saw a moment ago. These charts represent the supply curves for each of the other four sellers.
Added together, they give us a supply curve for the entire market. Again, though you can see the supply curve, the people in the experiment cannot. Similarly, the four buyers' demand curves can be added together to form a demand curve for the entire market. When the demand curve is superimposed on the supply curve, we can see where they intersect.
According to this model, the auction should result in eight units being sold at a price of between $3 and $4. Is this what really will happen? Let's find out. Everybody ready? Any questions?
Bet the market open. Seller X bids $5.50. Seller R asks $5.00.
Buyer K bids $4.20. Seller X asks $4.75. There's an acceptance, right?
Seller Q asks $4.50. Seller S asks $4.25. Acceptance, here. Buyer K. Seller W also asks $4.25. Acceptance.
Buyer F. Seller R asks $4.25. Acceptance. Buyer A, $425. Seller Q asks for. There's an acceptance here.
Buyer A accepts for. Seller W asks for $4. Another acceptance on the $4.
Buyer F. Seller X asks $3.75. And there's an acceptance. Seller J asks $3.25. Seller Q offers $3.50.
I see $3.50. I'm going to accept J. Acceptance?
Yeah. Seller R accepts $3.25. Seller Q asks $3.30.
Seller F bids $3.05. Seller Q asks $320. Okay, any other one?
Seller Q asks $312. Buyer? Buyer F bids $308. Any other buyers? Any other sellers?
Okay, the market's closed. At the end of the trading period, the students have a chance to calculate their net gains. Notice on the board there's eight transactions. Again, so quantity traded is eight, Q equals eight.
And the price hovered down to... 325 at the end but it came down towards that number so what the challenge for a model to describe the process of this market will be to see if it could predict this experimental outcome we'll have to look now at the experiment look at the data and see if you're market actually is well predicted by the model. As you can see, the experimental auction has demonstrated the accuracy of the supply and demand model.
There were eight transactions, exactly as predicted by the model. And the transaction price came down to between $3 and $4 as the market closed, which was also predicted. In other words, the model comes very close to predicting the outcome of the double oral market.