THE FIFTH MARKET EXPERIMENT

This sheet is intended to explain the rules of the fifth 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 on 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 a seller and it assigns an identifying number to the group. After that is a schedule. For sellers, the schedule indicates a distinct "cost" for each of seven units. For buyers, the schedule indicates a distinct "redemption value" for each of seven units.

Each seller group is eligible to sell up to seven units of an imaginary commodity. For each unit sold, sellers must purchase the unit from the experimenter (i.e., the professor). The price they must pay for each unit is itemized in the cost schedule. For example, suppose the cost of unit 1 is \$.75 and the cost of unit 2 is \$.90. Then if the group wants to sell one unit of the commodity it must pay the experimenter \$.75 for the unit. If it wants to sell a second unit it must pay the experimenter \$.90 for the unit, and so on. The profit it earns is the sum, across all units sold, of the difference between the sale price and the cost. For example, in the above example suppose a group sells two units for \$2.00 apiece. It earns \$1.25 profit on the first unit (i.e., the sale price of \$2.00 minus the cost of the first unit of \$.75) and \$1.10 profit on the second unit (i.e., the sale price of \$2.00 minus the cost of the second unit of \$.90), for a total proft of \$2.35. In addition, sellers are given a commission of \$.05 for each unit they sell. In the above example in which two units are sold, this would increase total profits to \$2.45. Sellers can sell anywhere from zero to seven units. For each unit, sellers can't sell the unit for less than its cost. In the above example, this means sellers could sell the first unit for \$.75 or more, but they could not sell the second unit for less than \$.90. and so on.

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, the number of units it wants to bid or offer, and its identifying number at the top of its sheet. For example, sellers offer to sell a specific number of units of the commodity at a specified price. They do this by saying: "seller number X offers to sell S units at a price of Y." Buyers bid to buy a specific number of units of the commodity at a specified price. They do this by saying: "buyer number Z bids a price of W for B units." In each offer sellers can offer anywhere from one to seven units at a specific price. Similarly, in each bid buyers can bid for anywhere from one to seven units at a specific price.

After an initial bid or offer is made the experimenter will ask if any group wants to accept all or part of the units bid or offered. If so then a transaction is completed. For example, suppose the first group chosen is a seller. Suppose the group offers to sell two units at a price of \$2.50 apiece. The experimenter will ask buyers who want to purchase both units for \$2.50 apiece 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 experimenter will then declare that a transaction has been completed at a price of \$2.50 for each of two units. The seller and buyer in the transaction will record on their sheets the price of the transaction for each of the units transacted. The seller will compute the difference between the price of the transaction and the price it must pay the experimenter for each of the two units sold, and it will add the commission of \$.05 for each unit. This yields its total profits. The buyer will compute the difference between the price it must sell each of the two units to the experimenter and the price of the transaction, and it will add the commission of \$.05 for each unit. This yields its total profits. Both the buyer and the seller will record this information on the appropriate spot on their sheets.

If no buyer is willing to buy two units at the price offered by the initial seller then the experimenter will solicit bids for each of the two units separately. If both units are not purchased then the experimenter 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 all of his/her seven units. 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 at least one 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 experimenter 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 a certain number of units. If sellers are not willing to sell all the units bid for at this price then higher bids are solicited from buyers until a seller is willing to sell at least one 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.

Two rounds of the experiment will be conducted. In the second round sellers will be offered a payment if they sell no units. The payment is recorded on their sheet under the column headed "Payment For Not Playing." This payment is operative only in the second round. No payment is offered for not selling any units in the first round. Sellers can receive the payment in the second round even if they make offers as long as none of the offers is accepted. In the second round buyers and sellers earn a \$.05 commission for a transaction beginning with the fourth unit transacted; no commission is paid for each of the first three units transacted whereas a \$.05 commission is paid on each unit transacted beginning with the fourth. Otherwise, for buyers, the rules of the second round are the same as the first round. The process of buying and selling in the second round is the same as the first round.

At the end of the experiment groups should hand in their sheets to the experimenter as they leave the classroom. The sheets should indicate the profits of the group and the name of each member of the group. The results of the experiment will be reviewed at the next class.