Experiments on Monopoly Behavior under the Double Auction Institution

Monopoly Experiments

Monopoly has been a source of concern for economists for a long time because of the welfare distorting effects that are associated with it. For a theoretical discussion of monopoly markets click here.

Description

In a monopoly market, there is a single seller with several (or many) buyers. The monopolist witholds output below the point where the price is equal to the marginal cost in order to maximize his profits. This leads to a decrease in total welfare.

Experimental overview

Vernon Smith ran monopoly experiments with different market institutions. Smith (1981) ran experiments to illustrate the effects of the type of trading institutions on a monopolist's ability to exercise market power. He compared the results between the double auctions and posted offers. The sessions were conducted under conditions of private incomplete information. In the double auction trading he found that there was a downward trend and that price were about mid way between the competitive and monopoly levels in the last half of the sessions. The index of monopoly effectiveness defined as below was approximately 0.6 in the final periods of the session.

M = (actual profit - competitive profit)/(monopoly profit - competitive profit)

In contrast, in the posted offer sessions achieved monopoly outcomes with five units sold and M = 1 Other double auction monopolies that fail to yield monopoly prices are reported in Smith and Williams (1989).

Possible explanations

Plott (1989) points out that the monopolist has trouble exercising power in a double auction because buyers do not behave as passive price takers. Instead they withhold purchases to curb monopolist's market power. A key to the monopolist's success in the posted offer market is due to the buyer's incentives as Kagel and Roth point out in their handbook on experimental economics. In the posted offer scenario if a buyer doesn't shop when he is given the opportunity there is no chance of recovering that lost profits later. So it is a dominant strategy for buyers to purchase all profitable units. In contrast, in the double auction setup buyers can hold out in the early period, knowing that if the price is not lowered as a result, they have a chance to make purchases later in the same period.

Available Software

The MarketLink experiment software can be used to compare monopoly outcomes from the Posted Offer market with those from the Double Auction market, as in Smith's experiment. For a discussion of the parameters used in Smith's experiment click here.

References

• Smith, V. (1981). An empirical study of decentralized institutions of monopoly restraint. In Essays in contemporary fields of economics in honor of E.T. Weiler, J. Quirk and G. Horwich, editors, West Lafayette: Purue University Press. 83-106
• Plott, Charles R. (1989). An updated review of industrial organization: Applications of experimental methods. In The Handbook of Industrial Organization Vol. II, R. Schmalensee and R.D. Willig, editors, Amsterdam: North Holland, 1109-76.
• Smith, V. and A. Williams (1983). An experimental comparison of alternative rules for competitive market exchange, In Auctions, Bidding, and Contracting: Uses and Theory, R. Englebrecht-Wiggans et al., editors, New York: New York University Press. 307-34