Students / Subjects

# Demand Curve Experiment

## Overview

The professor auctions off up to three M&M packets to the highest bidders via an open-exit format English auction. Students can only purchase one packet each. The auction begins with all students standing. The teacher gradually increases the price per packet from \$0 (often in 5 cent increments to speed up the process) and students sit down when the price reaches a level above what they are willing pay. By sitting down, a student is announcing that he or she is dropping out of the bidding and will not reenter. Students are instructed at beginning of the auction (and reminded during the auction) to write down on their index cards the price called immediately before the price that caused them to sit down (i.e., the price that represented the maximum amount that they were willing to pay for the M&M packet). When there are only three or fewer students standing, the auction ends (see below for rules when there are ties). The highest bidders are instructed to estimate the maximum amount that they were willing to pay for the M&M packet and write it down on their index cards. The teacher collects all index cards and enters the values into the EconPort supply and demand curve graphing screen (see below). The graphs form the basis of the lecture material on demand curves.

## Student Instructions

(These instructions are written assuming that the teacher reads them to students in class, but can easily be 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. Index cards can be passed out while the instructions are being read.)

I am now going to run a classroom auction. Please listen carefully as I read the instructions for this auction. I am passing out blank index cards and you should each take ONE card. You should not write anything on this card until told to do so.

I (the teacher) will be auctioning off to the highest bidders "fun size" M&M packets (1.69 oz), which you can see here in my hand. I will sell up to three packets. You can each purchase a maximum of one packet. Prior to participating in the auction, think about the maximum price at which you would be willing to buy an M&M packet. You will be required to pay in U.S. currency, so please do not bid values above \$0 if you are not prepared to pay.

The auction begins with every student standing, so please stand up now. I am writing on the board the starting price for the auction, which will be \$0. I will then begin to increase the price. By remaining standing, you are indicating that you would be willing to buy a packet of M&Ms at the price most recently announced. If at any point in the auction, the announced price rises above the maximum price at which you are willing to buy a packet, you should sit down.

When you sit down, please write on your index card the price that came before the announced price that caused you to sit down. In other words, write down the price that was either equal to or less than the maximum price that you were willing to pay for the M&M packet. You do not write anything else on the card.

The price will rise until three or fewer students remain standing. At this point the price stops rising and all bidders still standing will pay this price in exchange for a packet of M&Ms. I ask that these winning bidders estimate the maximum amount that they were willing to pay for the M&M packet, if the price had continued rising, and write it down on their index cards.

[optional text]: Please notice that in this auction (called an English auction), it is in your best interest to sit down only when the price rises above the maximum price you are willing to pay for a packet of M&Ms. You can do no better, and will sometimes do worse, by lying about your maximum price. You cannot do better by sitting down early or standing up after the price passes your maximum acceptable price. If you sit down early, you may miss out on buying a packet of M&Ms at a price less than what you would be willing to pay for the packet. If you remain standing too long, you may end up having to pay a price for the packet of M&Ms that is above what you normally would be willing to pay.

1. Avoiding Students Having to Pay in Real Currency: If you do not wish that the students pay in real currency, you can make the classroom experiment a hypothetical thought experiment. However, you cannot actually give the highest bidders the M&Ms in a thought experiment because students will find it costless to remain standing. Alternatively, you can try offering an endowment of extra credit points from which students can allocate to purchasing the M&M packets, but this approach has two disadvantages: (1) presenting the subsequent demand curves with a currency of extra credit points on the vertical axis may generate more confusion than elucidation in the lecture; and (2) students may not wish to part with scarce extra credit points for a packet of M&Ms and thus one might observe few reservation prices above zero.

2. Raising the price in 5-cent increments: By increasing the price in 5 cent increments, a teacher uses less time in lecture to conduct the experiment and generates a less complicated demand curves (i.e., fewer steps). The two disadvantages, which most teachers believe are small relative to the advantages, are that (a) 5-cent increments are less realistic than 1-cent increments, and (b) occasionally, more than three students remain standing and then after the final price increment, none remain standing. The latter problem can be remedied by either (1) using a tie-breaking rule to sell 3 packets at the previously announced price; or (2) backing up to the previously announced price and increasing the price in 1-cent increments (which may not remedy the problem, in which case (1) would have to be used). One easy tie breaking rule that doesn't require bringing to the class a randomization device (e.g., dice) is to recite the alphabet, starting at "A," and ask students to sit down after the letter that begins their last name is called. When only three students remain standing, the auction ends.

3. Ebay auctions as an illustrative example: You may find it worthwhile to mention "Ebay" when first using the word "auction" to offer a concrete example of a real-world auction.

4. Writing prices on the board: It is not necessary to write each 5-cent increment on the board, but it may facilitate students' memory of the price prior to the one at which they sat down.

## Data Entry

The data can be entered in class immediately after the experiment or out of class between lectures. Data entry in class is more transparent because students can see the values entered into the computer and then organized from highest to lowest. However, data entry in class takes away time from lecture. Data entry takes about 5 minutes of class with fewer than 75 students if one student reads the values and the professor enters them into the data screen.

1. Launch the Supply and Demand Graphing Tool.
2. On the 'Data' tab, enter data points from the index cards. You do not have to sort the index cards prior to entry. After data entry, name your data set (such as 'Demand for M&Ms') and press the 'Save as Demand Schedule' button.
3. Display the demand schedule by switching to the 'Chart' tab and selecting your newly-created data series.