THE FIRST MARKET EXPERIMENT

This sheet is intended to explain the rules of the first market experiment.

The objective of the experiment is to make profits. At the end of the semester the total profits earned by each individual on all the class experiments will be computed. Each individual will be issued a certain number of tickets based an the individual's total profits on the market experiments. A lottery will be conducted at the end of the semester in which tickets will be drawn for cash prizes.

To conduct the experiment the class will be divided generally into groups of three individuals. Each group is a team. Each group makes one decision which represents the desires of all three members of the group. Consequently, one person in each group should be designated as the spokesperson for the group. This person will be responsible for communicating the group's decisions.

Each group will be given a sheet at the start of the experiment. The first line on the sheet indicates whether a group is a buyer or seller and it assigns an identifying number to the group. The second line of the sheet records a price which for sellers is identified as "cost per unit" and for buyers is identified as "redemption' value per unit." The next three lines should be filled in with the names of the members of the group. Subsequent lines are to be used to record the results of the experiment.

Each seller group is eligible to sell one unit of an imaginary commodity. Sellers who sell one unit of the imaginary commodity must purchase this unit from the experimentor (i.e., the professor). The price they must pay the experimentor is recorded on the top of their sheet as the "cost per unit" of the commodity. For example, suppose a group designated to be a seller is distributed a sheet with a cost per unit of \$.90. This means that if the group wants to sell one unit of the commodity it must pay the experimentor \$.90. for the unit. The profit the group earns is the difference between the price the group sells its one unit for minus the price it must pay the experimentor for the one unit. For example, in the above example if the group sells its one unit for \$2.00 and the price it must pay the experimentor for the unit is \$.90, then its profit is \$2.00 - \$.90, or \$1.10. In addition, sellers are given a commission of \$.05 if they sell their one unit. In the above example, total profits would then equal \$1.15 when the commission is added in. Sellers are not allowed to sell a unit for less than they must pay the experimentor for the unit. In the above example this means that sellers cannot sell their one unit for less than \$.90.

Each buyer group is eligible to buy one unit of the imaginary commodity. Buyers who buy one unit of the imaginary commodity must sell the unit to the experimentor. The price at which they sell the unit to the experimentor is recorded at the top of their sheet as the "redemption value per unit" of the commodity. For example, suppose the redemption value per unit at the top of a buyer's sheet is \$2.00. This means that if the buyer purchases one unit of the commodity he/she can sell it to the experimentor for \$2.00. The profit of the buyer equals the difference between what the buyer can sell the unit to the experimentor for minus the price at which the buyer purchases the unit. For example, suppose in the above example that the buyer purchases one unit of the commodity for \$1.20. Then the buyer's profit equals \$2.00 - \$1.20, or \$.80. In addition, buyers are given a \$.05 commission if they buy a unit of the commodity. Buyers are not allowed to buy a unit for more than they can sell the unit to the experimentor. In the above example, this means that buyers cannot pay more than \$2.00 for their unit.

The process of buying and selling takes place as follows. At the beginning of the experiment and after each transaction, groups that want to make a bid or offer are asked to raise their hand. If multiple groups want to make a bid or offer then one group is chosen randomly. A group that is called on should always identify itself by the price it wants to bid or offer and its identifying number at the top of its sheet. For example, sellers offer to sell a unit of the commodity at a specified price. They do this by saying: "seller number X offers to sell one unit at a price of Y." Buyers bid to buy a unit of the commodity at a specified price. They do this by saying: "buyer number Z bids a price of W for one unit."

After an initial bid or offer is made the experimentor will ask if any group wants to accept the bid or offer. If so then a transaction is completed. For example, suppose the first group chosen is a seller. Suppose the group offers to sell a unit at a price of \$2.50. The experimentor will ask buyers who want to purchase a unit for \$2.50 to raise their hand. If multiple buyers raise their hands then one will be chosen at random. The group that is chosen will then announce its identifying number. The experimentor will then declare that a transaction has been completed at a price of \$2.50. The seller and buyer in the transaction will record on their sheets the price of the transaction. The seller will compute the difference between the price of the transaction and the price it must pay the experimentor for the unit it sold, and it will add the commission of \$.05. This yields its total profits. The buyer will compute the difference between the price it can sell the unit to the experimentor and the price of the transaction, and it will add the commission of \$.05. This yields its total profits. Both the buyer and the seller will record this information on the appropriate spot on their sheets. Once a group has made a transaction it cannot take any further actions. It has only one unit to buy or sell.

If no buyer is willing to buy a unit at the price offered by the initial seller then the experimentor will solicit a lower offer from sellers. He will ask sellers willing to make a lower offer to raise their hand. Any seller, including the seller who made the last offer, can make a lower offer as long as the seller has not yet sold his/her one unit. If multiple sellers raise their hands then one will be chosen randomly. Lower and lower offers will be solicited from sellers until some buyer is willing to purchase a unit at the offered price.

After a transaction is completed the process starts again. All previous bids and offers that did not lead to a transaction are erased. The experimentor asks groups who want to make a bid or offer to raise their hands. If multiple groups raise their hands then one group will be chosen randomly. If the initially chosen group is a buyer then the group bids a certain price for one unit. If no seller is willing to sell a unit at this price then higher bids are solicited from buyers until a seller is willing to sell a unit at the bid price. Then a transaction is completed and the process starts again. This process will be allowed to go on for 15 minutes. Then no further transactions will be allowed.

At the end of the experiment groups should hand in their sheets to the experimentor as they leave the classroom. The sheets should indicate the profits of the group and the name of each member of the group. Groups not making a transaction should record zero profits. The results of the experiment will be reviewed at the next class.