Experiments in Environmental Economics

Volume 1

Jason F. Shogren

• Publisher: Routledge
• Year: 2018
• Print ISBN:
  9781138717398
• eBook ISBN:
  9781351766791
• Topic: Social Sciences
• Subtopic: Politics
• Index: Social Sciences

This title was first published in 2003.Over the decades, experiential methods have become an established research tool in environmental economics. Economists working in this area have realised that experimental methods from economics and other disciplines such as psychology and decision theory can be applied to gain insight into the behavioral underpinnings of environmental policy. Economic experiments, in the lab and field, are an attractive tool to address the incentive and contextual questions that arise in environmental policy. Experiments have been and continue to be designed to capture the key elements of market and non-market choices to test theory, for pattern recognition, to testbed new institutions, and to value public goods, including environmental protection. This volume collects the most significant papers in the literature that identify the underpinnings of experimental approaches are complemented by works that specifically address the use of experimental economics to identify choice under risk, conflict, cooperation, environmental policy instruments, and environmental valuation

Part I
Motives and Methods

[1]

Microeconomic Systems as an Experimental Science

BY VERNONL L. SMITH*

Study nature, not books…

Louis Agassiz

After studying economics for six years I have reached the conclusion that there is no difference between discovery and creation…

[Graffiti by an unknown student]

The experimental literature contains only a few attempts to articulate a “theory” of laboratory experiments in economics (Charles Plott, 1979; Louis Wilde, 1980; my articles, 1976a, pp. 43–44, 46–47; 1976b; 1980). It is appropriate for this effort to have been modest, since it has been more important for experimentalists to present a rich variety of examples of their work than abstract explanations of why one might perform experiments. Wilde’s contribution provides an integration and extension of the earlier papers, and brings a fresh perspective and coherence that invites further examination. This seems to be the time and place to attempt a more complete description of the methodology and function of experiments in microeconomics.

The formal study of information systems in resource allocation theory (Leonid Hurwicz, 1960) and the laboratory experimental study of resource allocation under alternative forms of market organization (Sidney Siegel and Lawrence Fouraker, 1960, Fouraker and Siegel, 1963; my 1962, 1964 articles) had coincident beginnings and, in important respects, have undergone similar, if mostly independent, intellectual developments. The similarity of intellectual development in these two new endeavors is represented by the increasing focus upon the role of institutions in defining the information and incentive structure within which economic outcomes are determined. While the (new)² welfare economics (Stanley Reiter 1977) was articulating a formal structure for the design and evaluation of allocation mechanisms (institutions) as economic variables (Hurwicz, 1973), experimentalists were comparing the performance of experimental economies in which the rules of information transfer and of contract appeared as treatment variables (Plott and myself, 1978; my 1964, 1976a articles). Since it is not possible to design a laboratory resource allocation experiment without designing an institution in all its detail, it was foreordained by the nature of the questions asked, that the work of experimentalists would parallel that of the (new)² welfare economics.¹

In the sequel, the definition of a microeconomic system will be developed. Then the laboratory market or resource allocation experiment will be developed and discussed as an example of a microeconomic system. This framework will be used to provide a taxonomy for laboratory experimentation which allows the methods, objectives and results of such experiments to be interpreted and perhaps extended.² An important message of the paper which has been emphasized before (Plott, 1979, p. 141; my 1976b article, p. 275), but was articulated more satisfactorily by Wilde (1980), is that laboratory micro-economies are real live economic systems, which are certainly richer, behaviorally, than the systems parameterized in our theories. Consequently, it is important to economic science for theorists to be less own-literature oriented, to take seriously the data and disciplinary function of laboratory experiments, and even to take seriously their own theories as potential generators of testable hypotheses. Since “the discovery of new facts is open to any blockhead with patience and manual dexterity and acute senses” (attributed to Sir William Hamilton in N. R. Hanson, 1971, p. 23), it is equally important that experimentalists take seriously the collective professional task of integrating theory, experimental design, and observation.

I. Microeconomic System Theory

A. Defining a Microeconomic System

In defining a microeconomic system two distinct component elements will be identified: an environment and an institution.

1. The Environment

The environment consists of a list of N economic agents {1,…,N}, a list of K +1 commodities (including resources) {0,1,…,K}, and certain characteristics of each agent i, such as the agent’s utility function technology (knowledge) endowment Tⁱ, and a commodity endowment vector ωⁱ . Hence, the ith agent is characterized by the vector eⁱ = (uⁱ , Tⁱ, ωⁱ ) whose components are assumed to be defined on the K +1 dimensional commodity space R^{K+ 1}. Hence, a microeconomic environment is defined by the collection of characteristics e = (e^l,…,e^N ). This specification defines the environment as a set of initial circumstances that cannot be altered by the agents or the institutions within which they interact. The reader should appreciate that by appropriate interpretation this definition does not rule out learning, that is, changes in preferences and/or technology. But if learning is to be part of the economic process, then one must specify agent preferences and technology in terms of learning (or sampling or discovery) activities. In this case the fixed environment would specify the limitations and search opportunities for altering tastes and knowledge in an economy with changeable tastes and resources. It should be noted that, in an experimental environment, e will include some circumstances that cannot be altered by the agents because they are control variables fixed by the experimenter—a matter to which I will return later.

A subtle but important feature of the environment deserves emphasis: the superscript i on the characteristic of each agent i means that the initiating circumstances in an economic environment are in their nature private. Tastes, knowledge, and skill endowments are quintessentially private: I like, I know, I work, and I make.³

2. The Institution

The above is no less true in societies with weak than in those with strong private property right systems. Whether private tastes matter little or are sovereign; whether or not an idea can be patented, copyrighted, or trademarked as alienable private property; and to what extent one has a property right in the fruits of one’s “own” labor; these are all matters of the institution which is itself public in administration. It is the institution which specifies that soliciting for the purpose of prostitution is punishable by fines and imprisonment; that smoking in the hallway is to be allowed; that forms of indentured labor are prohibited (except in professional sports); that patents expire after seventeen years; that Ohm’s law is not patentable; that price discrimination is illegal (except m the Treasury bill auction); that trespassers will be prosecuted; and that no one has the right to obstruct free use of the air by airlines above private land (except that, at one time, alcoholic beverages were not to be served in flights over Kansas).

It is the institution that defines the rules of private property under which agents may communicate and exchange or transform commodities for the purpose of modifying initial endowments in accordance with private tastes and knowledge. Since all commodity exchange and commodity transformation must be preceded by interagent communication, property rights in messages are as important as property rights in commodities or ideas. Thus if stealing can lead to the charge of robbery or burglary, saying “your money or your life” can lead to the charge of attempted robbery. The institution defines the rights of private property which include the right to speak or not speak (you can’t say “one hundred” at an auction unless you mean to bid $100), the right to demand payment or delivery, and the right to exclude others from use, that is, to “own.” The institution specifies:

1. A language M = (M¹…,M^N ) consisting of messages m = (m¹,…,m^N ), where mⁱ is an element of Mⁱ , the set of messages that can be sent by agent i. A message might be a bid, an offer, or an acceptance. The allowable messages Mⁱ for i need, not be identical to M^j for j. Thus buyers may tender written bids at an auction, while the seller may have the right to offer or not offer an item for sale, but may not be allowed to bid on his own item or announce a reservation price.
2. A set H = (h¹(m),…,h^N (m)) of allocation rules for each i. The rule hⁱ (m) states the final commodity allocation to each i as a function of the messages sent by all agents. Since there may be an exchange of messages which precedes the allocation, m may refer to the final allocatíon-determining message.
3. A set C = (c¹(m),…c^N (m) of cost imputation rules. The rule cⁱ (m) states the payment to be made by each agent in numeraire units (money) as a function of the messages sent by all agents. Note that C is redundant in that it could be included in the definition of H, but it will be convenient in many applications (as when there are no income effects) to distinguish between commodity allocations by H and payment imputations by C.
4. A set G = (g¹(t₀, t, T),…, g^N (t₀,t,T)) of adjustment process rules. In general, these rules consist of a starting rule gⁱ (t₀,…) specifying the time or conditions under which the exchange of messages shall

begin, a transition rule (or rules) gⁱ (., t,.) governing the sequencing and exchange of messages, and a stopping rule gⁱ (.,., T) under which the exchange of messages is terminated (and allocations are to begin).⁴ For example, an English or progressive auction begins with an announcement by the auctioneer identifying the item to be offered for sale and calling for bids. The starting rule might also allow the seller to specify a reservation price. The transition rule requires any new bid to be higher than the previous standing bid. The stopping rule requires that no new overbid is obtained in response to a call from the auctioneer (for example, three calls for a “final” bid). In an unstructured bilateral negotiation, there is a starting “rule” in that bargaining cannot begin until there is a first bid or offer, and stops with an acceptance. Disputes concerning the negotiation process, and its outcome, are settled under the common law of contracts.

Each agent i’s property rights in communication and in exchange are defined by Iⁱ = (Mⁱ,hⁱ (m)cⁱ (m),gⁱ (t₀,t,T)), which specifies the messages that i has the right to send; the starting, transition, and stopping rules which govern these communication rights; and finally the right to claim commodities or payments in accordance with the outcome rules that apply to messages. A microeconomic institution is defined by the collection of all these individual property right characteristics I = (I¹,…,I^N ).

It should be noted that none of the above rules of an institution need be formal as in a body of written law. A rule can be simply a tradition as, for example, in the Eskimo polar bear hunting party in which the upper half of the bear’s skin, prized for its long mane hairs, was awarded to the individual hunter who (at great personal risk) was the first to fix his spear in the d...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Contents
• Acknowledgements
• Series Preface
• Introduction
• Part I Motives and Methods
• Part II Environmental Risk
• Name Index