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A Double Oral Auction Market ECO 110 Professor Mike Rizzo Friday, February 18th Introduction I. In class today, you will participate in an experiment that demonstrates how buyers and sellers interact in a market, and how market forces lead to market equilibrium. II. Recall what we mean by markets – we simply refer to any agglomeration of buyers and sellers. In other words, a market is any set of arrangements people use to make exchanges. The text makes no mention of the concept that markets can be organized in a number of ways. Market organization simply refers to the mechanism through which buyers and sellers communicate and execute transactions. Below are some examples: Posted Offer Market: These are markets you are most familiar with. In these Negotiation: Just as with used cars and commodities such as timber. Negotiated Sealed Bid Market: In these markets the prospective buyers of a product or service markets the sellers of a product or service list a price and the buyers of that product are free to either accept that price (and execute a transaction) or not accept that price (no trade occurs). Think “sticker price.” sales involve face-to-face bargaining between you and the buyer. You know the price you want to receive and the buyer knows the maximum price she will pay. submit confidential offers in writing for the product a seller wishes to sell. Sealed bidding limits your ability to negotiate prices, as all bids are opened at a specific place and time. If a bidder meets your minimum bid requirements, no further price negotiations should be pursued. o III. There are many more types of market organization. Although the organization of a market affects the way a price is determined, the same fundamental forces of supply and demand are at work in every market – so theoretically, the same market price would emerge in a market regardless of how it was organized. In today’s class, the market will be organized as a double oral auction. This is similar to how “pit” markets work (such as the Chicago Mercantile Exchange). Buyers yell out their bids (how much they want to pay for a particular good at this time) and sellers yell out their offers (how much they are willing to sell their good for at this particular time) so that all market participants can hear them. Instructions Each of you will be participating in the market for three-toed tree sloth hair. IV. After you have read these instructions I will hand you a card indicating whether you are a buyer or a seller in this market. Buyers Buyers will receive a card indicating a demand price or the maximum amount you would be willing to pay for a unit of tree sloth hair (although you prefer to pay lower prices). You might want to think of this number simply as how much you value tree sloth hair. Some of you like tree sloth hair more than others. If you can buy tree sloth hair for a price less than the total value to you, you have in some sense made a “personal profit” – a good deal for you. Economists call this concept consumer surplus. o For instance, if your buyer value is $60, that’s how much you are willing to pay for a unit of sloth hair. If you only have to pay $30 for it, you have in some sense “made” $30 – this is your consumer surplus. When interacting in the market, it makes sense not to pay MORE than the value on your card – you are spending more than you want to, so you ought not do it. You are indifferent if the price equals your value, so you should be willing to consider executing these trades. Your goal in this experiment is to maximize your personal profits, or your consumer surplus. 2 Sellers Sellers will similarly receive a card indicating a supply price or the minimum amount that they are willing to accept in exchange for a unit of tree sloth hair (although you prefer to receive a higher price for your good). You might think of this supply price as the marginal cost of production. Some of you may own a tree farm and tree sloths are plentiful, so it will not take much effort to give a sloth a buzz-cut. Some of you may not own a tree farm and therefore must travel to a public park, find a sloth and then give it a haircut – this is more costly. For the purposes of this experiment, tree sloth hair is made to order – so that you only cut hair if you make a sale. In other words, if you cannot sell a unit of tree sloth hair at your offer price, you incur no costs. If you can sell a unit of tree sloth hair for more money than it costs you to make it, you have made a profit. Economists often refer to the profits of firms as producer surplus. o For instance, if it costs you $40 to cut the hair off of a sloth, and you can sell that hair for $75, then you have made a $35 profit on the sale of that unit of hair. When interacting in the market it would make little sense for you to sell a unit of sloth hair for a price LESS than it costs you to make it – you would be losing money. You are indifferent if the price you can fetch is exactly equal to your cost of production – so you should be willing to make these trades. Your goal in this experiment is to make as much in profits as you can. 3 Guidelines a) The three students with the largest consumer surplus and the three students with the largest producer surplus after the experiment will be able to “drop” three questions from being graded on the next problem set (you still need to do them of course). b) Put your name on buyer – seller sheet when you receive it. c) Do not reveal your value or costs to others in the class. This might be obvious to you – if a bag of sloth hair is worth $100 to you, would you want the suppliers to know this when it might only cost them $20 to make it? d) Your goal as both buyers and sellers is to make as much “surplus” as possible. e) When a buyer and seller have executed a trade – i.e. agreed to a sale price – come to me at the front of class so that I can record the value in my spreadsheet. f) You can only buy one unit if you are a buyer and you can only sell one unit if you are a seller. After a transaction has occurred, mark it into your Buyers or Sellers record sheet, and then move aside so that you do not interfere with the remainder of the trading. g) Each round is independent – so after each round the slate is clean. You may trade with the same person in each round or you may “shop around.” However, your buyer value remains the same in each round as does your seller cost. h) You might want to take note of the prices of transactions that are taking place in the room around you. i) Trading will start at my signal and each round will last 3 – 4 minutes. Be prepared for loud and vigorous trading. o When the trading begins – buyers will SHOUT out “bids” – in other words, if you are a buyer, announce to the class how much you want to pay for an item. If there is a willing seller, she might accept the bid. o When the trading begins – sellers will SHOUT out “asks” (you can see how this gets crazy) – in other words, if you are a seller, announce to the class how much you wish to receive for the sale of your product. If there is a willing buyer, she might accept the offer. o As each trade is executed, I will announce to the class the price that this last unit sold for. j) Please feel free to move around the room – be sure to call out your bids or offers loudly and take your time “shopping around” for the best prices. 4