Less Rationality, More Efficiency: a Laboratory Experiment on "Lemons" Markets

Prof. Dr. Roland Kirstein and Annette Kirstein
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Annette Kirstein: Universität Karlsruhe

No 2005-1-1125, German Working Papers in Law and Economics from Berkeley Electronic Press

Abstract: In this paper we experimentally test a theory of boundedly rational behavior in a "lemons market." We analyzed two different market designs, for which perfect rationality implies complete and partial market collapse, respectively. Our empirical observations deviate substantially from these predictions of rational choice theory: Even after 20 repetitions, the actual outcome is closer to e±ciency than expected. Our bounded rationality approach to explaining these observations starts with the insight that perfect rationality would require the players to perform an in¯nite number of iterative reasoning steps. Boundedly rational players, however, carry out only a limited number of such iterations. We have determined the iteration type of the players independently from their market behavior. A significant correlation exists between the iteration types and the observed price offers.

Keywords: guessing games; beauty contests; market failure; adverse selection; lemon problem; regulatory failure; paternalistic regulation (search for similar items in EconPapers)
JEL-codes: D8 C7 B4 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cbe, nep-exp, nep-gth and nep-reg
Note: oai:bepress:gwp-1125
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