Supply, Demand, and Equilibrium: A Class Experiment

Abstract

This note explains the intuition and analytics behind the class experiment that is commonly called Trading in a Pit. Following the experiment, we derive supply and demand and discuss market efficiency. This note is part of the refresher course in economics at Darden. Excerpt UVA-G-0593 Rev. Aug. 18, 2009 Supply, Demand, and Equilibrium: A Class Experiment Today's class experiment goes back to an exercise by, among others, Vernon Smith, the 2002 Economics Nobel Laureate. The experiment mimics trading on the floor of commodities markets around the world. It illustrates the power of the supply and demand framework. With supply and demand, we could actually predict with reasonable accuracy the number of tons of wheat bought and sold each day and at what price. During the experiment in class, we discovered that decentralized markets are extraordinarily efficient tools, which is why policymakers often prefer them to centralized markets. Competition among traders ensures that only those transactions materialize that will maximize the total profits of consumers and producers. With a simple example, this note summarizes and discusses our main findings from the experiment. Predicting Equilibrium Prices and Quantities Consider a market for homogeneous goods such as wheat. There are six buyers and six sellers of a given amount of wheat. Sellers make money when they sell above the value on their cards, which is the production cost of the wheat. Buyers, on the other hand, make a profit when they buy wheat at a lower price than the value on their cards, which is their willingness to pay. Take the following values for buyers' willingness to pay and for sellers' production costs. . . .