Experimental economics: UAA's program holds international esteem.

• Author: Murphy, James
• Position: EDUCATION - University of Alaska Anchorage

Grape farmers in central Chile had a problem. Their world-famous vineyards required a steady supply of water, but the region was susceptible +to droughts. Growers of annual crops, like wheat and corn, had more flexibility to deal with these water shortages and could sell water to grape farmers. The challenge was figuring out how to connect buyers and sellers.

Typically these water trades occur between friends and neighbors, but the process was time consuming and trading partners can be hard to find. A UAA economics professor and his Chilean colleagues had ideas for an online marketplace that might improve the current system. But how could they be sure? And how could they convince the farmers to adopt their idea?

To answer these questions, the researchers used the tools of experimental economics, a field pioneered by Vernon Smith, 2002 Nobel laureate and UAA's first Rasmuson Chair of Economics. Smith recognized that although markets can be incredibly efficient, their success depends upon the rules governing trade. To determine which market design would perform best, the researchers tested their ideas using carefully controlled laboratory experiments--in much the same way that new pharmaceutical drugs are rigorously tested before being adopted.

How does an economics lab experiment work? Researchers design an experiment that captures the key features of a "real world" market under study, such as Chilean water. Participants are assigned the roles of buyers and sellers making trades. They have an incentive to think carefully about their decisions since the money they earn from trading is theirs to keep.

During the experiment, researchers can change the rules of exchange and the incentives--and by observing how the participants' behavior changes as the rules or incentives change, they can evaluate the market performance. They can compare results of the experiment with theoretical predictions.

In the past twenty years, the field has grown rapidly. Lab experiments have been used in a number of high profile contexts, including the multi-billion dollar FCC spectrum license auctions, the design of emissions trading programs, and the allocation of space on the Cassini mission to Saturn. Many large corporations, including Google, Yahoo, and Microsoft, have added experimental economists to their teams.

As modern experimental economics has expanded its range, it has also developed new methods. While laboratory studies using college students remain a core...