During the very first lectures of Economics 101, students learn that, according to Adam Smith, supply and demand determine the price and quantity of goods sold. In reality, however, this relationship can only rarely be verified. Usually, markets are affected by numerous other forces that cannot be controlled and therefore falsify the results.

To make headway in understanding markets and economic behavior, economists initially resorted to additional assumptions, parameters, and variables. But the difficulties persisted, and instead of getting closer to a solution, all that happened was that the models became more intricate, unmanageable, and unrealistic.

So economists, taking a page from the books of physicists and chemists, tried to verify their theses by carrying out experiments. They set up labs in which “real” market situations were simulated as well as possible. Test persons were then observed making decisions and participating in economic activities. It was the birth of experimental economics.

Edward Chamberlain of Harvard University pioneered the experimental approach to economics some 50 years ago, using Harvard students as guinea pigs. Unfortunately, his results deviated from neoclassical market theory. The experiments showed volume to be typically higher and prices to be typically lower than was predicted by competitive models of equilibrium. A few years later Vernon Smith, one of Chamberlain’s students, refined his former professor’s methods. His experiments yielded near-equilibrium prices and quantities and finally gave experimental confirmation of the classical theory. For his work Smith received the Nobel Prize for Economics in 2002, together

with the American-Israeli behavioral psychologist Daniel Kahneman, who pursued the same line of research.

In a new experiment the economist John List, from the University of Maryland, subjected the classical theory yet again to an experiment. In doing so, he made some remarkable observations that have been published in the Proceedings of the National Academy of Sciences. The economic goods that List used were baseball cards, hot items among aficionados. To find his guinea pigs, the professor went to a collectors market. He asked a number of traders and visitors if they would be willing to participate in an experiment. The “players” were then subdivided into four groups: buyers, sellers, novices, and experienced “old hats.” Each seller received a card of a well-known baseball player. The image had been purposely defaced through the addition of a moustache to the player’s likeness. Thus the card had lost all its value for real collectors, which ensured that the participants in the experiment would not take off and trade the card for money at the real market next door.

Then List allocated maximum buying prices to each buyer and minimum sales prices to each seller. These reserve prices were staggered in such a way that they produced offer and demand curves that intersected at seven cards and a price of between $13 and $14. For five minutes the participants were allowed to find partners and to higgle and haggle, dicker and chaffer, until they could agree on a price—or not. Efficiency of this artificial marketplace was measured in terms of whether the price and volume of the cards “sold” in the experiment corresponded to the predictions of classical theory.

Indeed, the results of List’s experiment approximated the results predicted by theory. In 18 out of 20 cases between 6 and 8 cards were traded, and in 10 cases the average price of the cards equaled the predicted value.

But List noted a further detail: Market experience played an important role in determination of the market’s efficiency. It was at its most efficient when inexperienced buyers chanced up experienced sellers. And the market was at its most inefficient when both buyers and sellers

were experienced old hats. Apparently, too much familiarity with the rules of the game may prove a hindrance to trading partners, who are keen to find a price acceptable to both parties—a somewhat discouraging observation for believers in a free market economy.