The Market: Catalyst for Rationality and Filter of Irrationality

Abstract Assumptions of individual rationality and preference stability provide the foundation for a convenient and tractable modeling approach. While both of these assumptions have come under scrutiny in distinct literatures, the two lines of research remain disjointed. This study begins by explicitly linking the two literatures while providing insights into whether market experience mitigates one specific form of individual rationality—consistent preferences. Using field experimental data gathered from more than 800 experimental subjects, we find evidence that the market is a catalyst for this type of rationality. The study then focuses on aggregate market outcomes by examining empirically whether individual rationality of this sort is a prerequisite for market efficiency. Using a complementary field experiment, we gathered data from more than 380 subjects of age 6-18 in multi-lateral bargaining markets at a shopping mall. We find that our chosen market institution is a filter of irrationality: even when markets are populated solely by irrational buyers, aggregate market outcomes converge to the intersection of the supply and demand functions.

[1]  Louis Phlips,et al.  A Dynamic Version of the Linear Expenditure Model , 1972 .

[2]  H. Houthakker,et al.  Consumer demand in the United States : analyses and projections , 1970 .

[3]  K. May.  Intransitivity, Utility, and the Aggregation of Preference Patterns , 1954 .

[4]  M. Manser.  ELASTICITIES OF DEMAND FOR FOOD: AN ANALYSIS USING NON- ADDITIVE UTILITY FUNCTIONS ALLOWING FOR HABIT FORMATION* , 1976 .

[5]  N. Georgescu-Roegen.  The Theory of Choice and the Constancy of Economic Laws , 1950 .

[6]  John H. Miller,et al.  NOTES AND COMMENTS GIVING ACCORDING TO GARP: AN EXPERIMENTAL TEST OF THE CONSISTENCY OF PREFERENCES FOR ALTRUISM , 2002 .

[7]  Tjalling C. Koopmans,et al.  On Flexibility of Future Preference , 1962 .

[8]  Reinhard Sippel,et al.  An Experiment on the Pure Theory of Consumer'S Behaviour , 1997 .

[9]  M. Satterthwaite,et al.  Efficient Mechanisms for Bilateral Trading , 1983 .

[10]  Robert Slonim,et al.  Learning rules of thumb or learning more rational rules , 1999 .

[11]  Daniel L. Millimet,et al.  On the Specification of Propensity Scores: With Applications to the Analysis of Trade Policies , 2006 .

[12]  D. Heien,et al.  The S-Branch Utility Tree: A Generalization of the Linear Expenditure System , 1972 .

[13]  William T. Harbaugh,et al.  Garp for kids: On the development of rational choice behavior , 2001 .

[14]  James Andreoni,et al.  Giving according to GARP: an experimental study of rationality and altruism , 1997 .

[15]  J. List.  The nature and extent of discrimination in the marketplace: Evidence from the field , 2004 .

[16]  A. Schotter,et al.  Endogenous Preferences : The Cultural Consequences of Markets and other Economic Institutions , 1999 .

[17]  Dhananjay K. Gode,et al.  Allocative Efficiency of Markets with Zero-Intelligence Traders: Market as a Partial Substitute for Individual Rationality , 1993, Journal of Political Economy.

[18]  Vernon L. Smith,et al.  Experimental Auction Markets and the Walrasian Hypothesis , 1965, Journal of Political Economy.

[19]  E. Chamberlin,et al.  An Experimental Imperfect Market , 1948, Journal of Political Economy.

[20]  Colin Camerer.  Behavioral Game Theory: Experiments in Strategic Interaction , 2003 .

[21]  D. Rubin,et al.  The central role of the propensity score in observational studies for causal effects , 1983 .

[22]  Colin Camerer.  Behavioral Game Theory , 1990 .

[23]  M. Toda,et al.  The Experimental Determination of Indifference Curves , 1969 .

[24]  R. Pollak.  Endogenous Tastes in Demand and Welfare Analysis , 1978 .

[25]  R. L. Basmann,et al.  A TEST OF CONSUMER DEMAND THEORY USING OBSERVATIONS OF INDIVIDUAL CONSUMER PURCHASES , 1973 .

[26]  T. Wales.  A Generalized Linear Expenditure Model of the Demand for Non-durable Goods in Canada , 1971 .

[27]  T. Dee.  Teachers, Race, and Student Achievement in a Randomized Experiment , 2001, Review of Economics and Statistics.

[28]  Petra E. Todd,et al.  Matching As An Econometric Evaluation Estimator: Evidence from Evaluating a Job Training Programme , 1997 .

[29]  Colin Camerer.  Do Markets Correct Biases in Probability Judgment? Evidence from Market Experiments , 1990 .

[30]  V. Smith.  Experimental Economics : Induced Value Theory , 2007 .

[31]  H. Varian.  The Nonparametric Approach to Demand Analysis , 1982 .

[32]  R. Stone.  Linear expenditure systems and demand analysis : an application to the pattern of British demand , 1954 .

[33]  J. Heckman.  The Common Structure of Statistical Models of Truncation, Sample Selection and Limited Dependent Variables and a Simple Estimator for Such Models , 1976 .

[34]  张谷.  实验经济学（Experimental Economics）研究思路及成果应用简述 , 1994 .

[35]  V. Smith.  An Experimental Study of Competitive Market Behavior , 1962, Journal of Political Economy.

[36]  Robert Forsythe,et al.  Anatomy of an Experimental Political Stock Market , 1992 .

[37]  John A. List,et al.  Testing Neoclassical Competitive Theory in Multilateral Decentralized Markets , 2004, Journal of Political Economy.

[38]  A. Roth.  Introduction to Experimental Economics , 2004 .

[39]  G. Becker,et al.  Irrational Behavior and Economic Theory , 1962, Journal of Political Economy.

[40]  G. Imbens,et al.  Efficient Estimation of Average Treatment Effects Using the Estimated Propensity Score , 2000 .