DEFINITION of Experimental Economics

Experimental economics is a branch of economics that studies human behavior in a controlled laboratory setting or out in the field, rather than just as mathematical models. It uses scientific experiments to test what choices people make in specific circumstances, to study alternative market mechanisms and test economic theories.

BREAKING DOWN Experimental Economics

Experimental economics is used to help understand how and why markets function like they do. These market experiments, involving real people making real choices, are a way of testing whether theoretical economic models actually describe market behavior, and provide insights into the power of markets and how participants respond to incentives – usually cash.

The field was pioneered by Vernon Smith, who won the Nobel Prize in Economics in 2002, for developing a methodology that allows researchers to examine the effects of policy changes before they are implemented, and help policymakers make better decisions.

Smith’s early experiments focused on theoretical equilibrium prices and how they compared to real-world equilibrium prices. He found that even though humans suffer from cognitive biases, traditional economics still can make accurate predictions about the behavior of groups of people. Groups with biased behavior and limited information still reach the equilibrium price by becoming ‘smarter’ through their spontaneous interaction.

Together, with behavioral economics – which has established that people are a lot less rational than traditional economics had assumed — experimental economics is being also being used to investigate how markets fail, and explore anticompetitive behavior.