Market Experiment with Handheld Classroom Response Systems ("Clickers")
In this experiment, students participate as buyers and sellers in a competitive market. Unlike the Competitive Equilibrium teaching module, this experiment uses a "real" good; therefore the students' own marginal benefit for the good determines the Demand curve and other students' own marginal cost for the good determines the supply curve. The market equilibrum is derived from the classroom demand and supply curves. Using a call-market institution, the market price and quantity traded is determined by the price at which quantity demanded is equal to quantity supplied.
Students sometimes doubt the textbook presentation of the supply or demand model, or simply memorize that equilibrium occurs whenever two lines intersect one another. Moreover, when the emphasis is on theory and graphs, students may easily lose track of the fact that the supply and demand model should be able to predict how prices and quantities actually react to changing market conditions. This experiment illustrates the concept that equilibrium occurs when the number of buyers who are willing to buy at a price is equal to the number of sellers who are willing to sell at a price. By actively engaging in the market students are better able to extrapolate from the basic model the impact of other economically-relevant issues such as changes in the numbers of buyers and sellers, changes in income, price controls and taxes.
Time Required: This experiment and associated discussion can be conducted in one class period. The experiment takes less than 10 minutes, and the rest of the class period can be spent leading class discussion.
The professor gives about half of the class a fun-size candy bar or other inexpensive item. These students are the sellers in the market, and the remaining students are buyers. Bids and offers are submitted to the professor by entering them using their clicker's keypad. Buyers are asked to submit the the maximum price at which they are willing to buy the item. After all buyers are have submitted their bids, sellers are asked to submit the minimum price for which they are willing to sell the item. A spreadsheet can be used to quickly determine the market price and quantity in the market. After this, these bids and asks are entered into Econport's supply and demand curve graphing screen. This allows the instructor to generate a visual representation of the market demand and supply and the equilibrium price in this market.
(These instructions are written assuming that the teacher reads them to students in class, but can be easily modified for reading outside of class prior to the lecture period. They can also be given in writing to students, but many professors simply read them to the students and highlight the key rules on the board.)
I am going to conduct a classroom auction in which some of you will be buyers and some of you will be sellers. The rules of this auction are a little different than some you might be familiar with (such as EBay), so please listen carefully. I am giving half of you a fun-size candy bar - don't open or eat this candy bar until we are done with this auction.
Instructions for Sellers
Those of you who have candy bars are sellers in this market. You should think about the lowest price you would be willing to accept to sell the candy bar to another person in this class. After the experiment starts I will ask you to enter this price using your clicker - just enter the price in cents; so if you were willing to sell it for 15 cents you would enter "15" but if you wanted to sell it for $1.50 you would enter "150".
This isn't necessarily the price that you will receive if you sell your candy bar - how the price is determined will be explained in a minute - but it tells me at what prices you would be willing to sell. For example, if you entered 15-cents, this tells me that you are willing to sell it if the price is 15-cents or higher, but not if it is lower than 15-cents. If you entered 150-cents, this tells me that you are not willing to sell if the price is less than $1.50. Using this example, if the market price turned out to be 75-cents, you will sell your candy bar (and receive 75-cents for it) if you entered a price of 15-cents, but NOT if you entered an offer price of 150 cents.
When you enter your minimum selling price it is important that you truthfully enter the lowest price that is acceptable to you. If you enter something higher than this, you may lose the opportunity to sell. For example, suppose you entered a price of 40-cents but were actually willing to sell for 20-cents. If the market price was 30-cents you would NOT sell your candy bar because you said you were not willing to sell for anything less than 40-cents. On the other hand, you don't want to put in a price lower than your lowest acceptable price - if you did this you would risk having to sell at a price lower than you actually wanted to receive.
Instructions for Buyers
If you do not have a candy bar, you are a buyer in this market. You should think about the highest price you would be willing to pay to buy the candy bar from another person in this class. After the sellers enter their offer prices, I will ask you to enter the highest price you are willing to pay using your clicker - just enter the price in cents; so if you were willing to buy it for 15 cents you would enter "15" but if you wanted to buy it for $1.50 you would enter "150".
This isn't necessarily the price that you will pay if you buy a candy bar - how the price is determined will be explained in a minute - but it tells me at what prices you would be willing to buy. For example, if you entered 15-cents, this tells me that you are willing to buy it if the price is 15-cents or lower, but not if it is higher than 15-cents. If you entered 150-cents, this tells me that you are not willing to buy if the price is greater than $1.50. Using this example, if the market price turned out to be 75-cents, you will buy your candy bar (and pay 75-cents for it) if you entered a price of 150-cents, but NOT if you entered a bid price of 15 cents.
When you enter your maximum buying price it is important that you truthfully enter the highest price that is acceptable to you. If you enter something lower than this, you may lose the opportunity to sell. For example, suppose you entered a price of 60-cents but were actually willing to buy for 80-cents. If the market price was 70-cents you would NOT buy a candy bar because you said you were not willing to buy for anything more than 60-cents. On the other hand, you don't want to put in a price higher than your highest acceptable price - if you did this you would risk having to buy at a price higher than you actually wanted to receive.
You should be sure you have at least as much money with you (in cash) as you bid so that you can pay for the candy bar if your bid is accepted in the market.
How we Determine the Market Price and Quantity Traded
After all sellers have submitted their offer prices and all buyers have submitted their bid prices I will organize the bids and offers in the following way to determine the market price and quantity:
Once the outcome is determined, have all students who submitted accepted bids or offers come to the front of the room; buyers should give the sellers the market price in exchange for the candy bar. At this point, anyone with a candy bar may be allowed to eat it.
Examples of how the market price and quantity are determined:
Here are some examples to help you see how the market price is determined and which students will trade in this auction:
Example 1: Suppose that we have the following bids and offers in the auction
In this example, at a price of 50-cents there are 4 buyers who are willing to buy and 4 sellers who are willing to sell. So the market price is 50 cents. The first 4 sellers will sell their candy bars to the first 4 buyers. Each of these buyers will pay 50-cents to the seller. The last buyer will not buy because this student said he would pay no more than 45-cents. The last seller will not sell because he said he would accept no less than 80-cents. Given these bids and offers, there is no price that would be agreeable to both the last buyer and the last seller.
Example 2: Suppose that we have the following bids and offers in the auction
In this example, the last buyer and seller will still not trade in this market because there is no price that is acceptable to both of them. But there are several prices that would be acceptable to all of the other students in the market. For example, if the market price were 54 cents, each of the first 4 buyers have stated that they are willing to buy at a price of 54 cents (in fact, the first 3 buyers would pay even more than this). Similarly, the first 4 sellers are all willing to sell at a price of 54 cents (or lower). If we go down to a price of 50-cents, the first 4 buyers and sellers are still willing to trade.
In a situation like this where there is more than one price that satisfies the same number of buyers and sellers the market price will be the average of the acceptable prices. In this example prices between 50 and 54 are acceptable, so the market price will be 52 cents.
Example 3: Suppose that we have the following bids and offers in the auction
Depending on when you conduct this experiment, you can organize the lecture and class discussion in several ways. If you conduct this at the beginning of the semester, you might want to talk about the bids and Demand curve initially, the offers and Supply curve when you are ready to cover supply, and the market results when you cover equilibrium. As an alternative, you can use the Demand and Supply module at the beginning of the semester and this module when you get to equilibrium. In this case, your lecture can focus on the latter parts of the lecture.
Demand and Supply
Many students have trouble understanding why bids to buy are ranked from highest to lowest, while offers to sell are ranked from lowest to highest. One way to help students with this is to have them think about more familiar auction institutions, such as English (ascending) auctions such as those used at antiques sales or Ebay auctions.
Start by asking students about whether they've ever participated in or observed an Ebay auction - most students have some familiarity with these auctions. Ask why someone might choose to sell something in an auction. You want to guide students to the idea that it is a way to get peoplle to reveal what an item is worth to them by competing with others in the auction or that if you just offer something for a given price you might not get as much as if you ask people to bid against one another in an auction. Next, ask a student to explain how an Ebay auction works. The idea you want to get to is that someone posts something for sale (maybe with a minimum price) and people post bids, with the highest bid at the end of the time winning.
This will lead you to the point that in most auctions the person with the highest bid will win the auction. After this, you can ask them what would happen in an auction when there are two goods for sale. Students should realize that the top two bidders will win. Through this discussion you can guide them to the idea that higher bids have priority over lower bids in auctions, and so if you were going to "rank" bids in the order in which they should be fulfilled you would start with the highest bid and work your way down to progessively lower bids. It is also worthwhile to ask students to think about why this is "good" in terms of efficiency - the idea here is that people who value the good the most will have the highest bids and it makes sense that goods should go to the people who value them the most.
Most students will be less famliar with auctions in which sellers compete against one another to sell a good. You can start this part of the discussion by asking students if they can think of examples of this. If they have trouble, ask them how a city decides what company to hire to build a new building. Typically someone will realize that they send it out for bids, with the lowest bidder typically winning the contract. You can lead this discussion to a parallel manner to the demand discussion so that students realize that one would prefer to buy from the seller with the lowest offer price, and then move on to progressively higher offers.
Thiis example is a little harder because there is no price at which the number of buyers willing to buy is equal to the number of sellers willing to sell. In this case, it might help to look at each pair separately. If you look at the first buyer and seller, there are a lot of prices at which they would be willing to trade (anything from 20-67); the same is true of the second buyer and seller (any price between 45 and 65 would be acceptable). For the third pair, the only price that is mutually acceptable is 60-cents. However, there is no price that is acceptable to both the buyer and seller for the 4th or 5th pair. For the last two buyers and sellers, the highest price the buyers are willing to pay is less than the lowest acceptable price for the sellers.
Given this, the most people that are willing to trade is three, and 60-cents is the only price that will allow three buyers and sellers to trade. So in this case, the market price is 60-cents and three buyers and sellers will trade. Because there are a total of 4 buyers who are willing to buy at this price but only 3 sellers who will sell this means that only 2 of the buyers with bids=60 will be able to buy. The first of these buyers to submit a bid will be allowed to buy. (Note to instructor: if your clicker software does not record the time each answer was submitted, you can randomly choose among these two buyers)
At this point, you can use the Demand and Supply graphing tool and your class' bids and offers to create demand and supply curves for the classroom market. You don't have to type in each bid and offer. You can copy all bids from the spreadsheet to create the market demand curve, then copy all offers to sell to create the market supply curve. The lecture notes in the Demand and Supply module provides a detailed discussion of how to explain these discrete (step-function) curves to your class and how they relate to the smooth textbook presentation of supply and demand curves.
Once the demand and supply curves are created, students can see a visual representation of how the market price was determined. You can point out to students that the market outcome balances the demands of both buyers and sellers. At the market price, all buyers in the market were able to buy the good at a price that was less than or equal to their stated value for the good - so all buyers received a benefit from being able to buy the candy bar at the market price. At the same time, all sellers in the market were able to sell the good at a price that was greated than or equal to their stated value for the good - so all sellers received a benefit from being able to sell the candy bar at the market price.
Some students may point out that some buyers and sellers were left out of the market, and you should encourage the class to talk about this. Ask a seller who entered a very high offer price why they did so - you may get a number of answers (including some who thought they could benefit by over-stating their minimum selling price), but you should keep the discussion going until a student says that they asked for a high price because they really wanted the candy bar. At this time, you can point out that this person did not sell the good but was able to enjoy it. You can also relate this to opportunity cost - the student's opportunity cost of selling the candy bar was too high to be able to sell it in the market. Therefore, it was good that this person kept it and others with a lower opportunity cost sold instead. You can guide the discussion about low-valued buyers in a parallel manner. For example, some students may not like chocolate or may not have been hungry and therefore they submitted low bids (or possibly did not submit a bid at all). You can help the class to realize that it is good that higher-valued buyers were able to purchase instead.
Most students will be unfamiliar with this type of auction and so they may wonder what it has to do with the textbook presentation of competitive markets. You can point out to your students that the textbook presentation of the supply and demand model doesn't say anything about the market institution - the rules that determine how buyers and sellers interact in a market. You can ask students how prices are typically determined. They might say that sellers just decide, but you can point out that sellers choose a price and then buyers can decide whether to purchase or not (or to look for another seller with a lower price). Summarize this by pointing out that in most cases, buyers cannot choose the price they want to pay - they just have to "shop around" to see if they can find an acceptable price. The institution used in most retail markets in the US is a posted offer market. Next, ask someone to describe how stocks are bought and sold in the US. Most stocks are sold in a "double auction" market - sellers call out offers to sell and buyers simultaneously call out bids to buy. A sale is made when a buyer and a seller mutually agree on a price. There are also examples of "decentralized bilateral bargaining" - for example, at some flea markets buyers go from booth to booth and negotiate with individual sellers. It is similar to a double-auction except that there is no central place where bids and offers are made - bargaining occurs in a one-on-one basis.
The institution used in this experiment is a "call market." While not as widespread as other institutions, it is used in some financial markets - in particular those with lower volume of trade than in the New York Stock Exchange. In these markets buyers are allowed to submit bids to buy and sellers submit offers to sell. At an announced time the market closes, bids are ranked from high to low, offers are ranked from low to high. As in the classroom market, the intersection of the bids and asks determines the market price and volume. After this "market crossing" participants are once again free to submit new bids and offers.
Once students have participated in this experiment, they will have first-hand experience that will help you to explore other topics with them. Depending on your course organization you can introduce these topics right after the experiment or in future class periods when you typically cover these topics. We suggest a few extensions that you can explore with your class, but this is not an exhaustive list.