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Less Rationality, More Efficiency: a Laboratory Experiment on "Lemons" Markets

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  • Kirstein, Annette
  • Kirstein, Roland

Abstract

In this paper we experimentally test a theory of boundedly rational behavior in a "lemons market." We analyzed two different market designs, for which perfect rationality implies complete and partial market collapse, respectively. Our empirical observations deviate substantially from these predictions of rational choice theory: Even after 20 repetitions, the actual outcome is closer to efficiency than expected. Our bounded rationality approach to explaining these observations starts with the insight that perfect rationality would require the players to perform an infinite number of iterative reasoning steps. Boundedly rational players, however, carry out only a limited number of such iterations. We have determined the iteration type of the players independently from their market behavior. A significant correlation exists between the iteration types and the observed price offers.

Suggested Citation

  • Kirstein, Annette & Kirstein, Roland, 2004. "Less Rationality, More Efficiency: a Laboratory Experiment on "Lemons" Markets," CSLE Discussion Paper Series 2004-02 [rev.], Saarland University, CSLE - Center for the Study of Law and Economics.
    • Handle: RePEc:zbw:csledp:200402r
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    References listed on IDEAS

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    Cited by:

    1. Roland Kirstein & Annette Kirstein, "undated". "Europäischer Verbraucherschutz – Ausdruck grenzenloser Regulierungswut oder sinnvoller Schutz für Käufer? Erkenntnisse aus einem Laborexperiment," German Working Papers in Law and Economics 2006-1-1160, Berkeley Electronic Press.
    2. Kirstein, Roland, 2004. "Internationaler Müllhandel: Eine institutionenökonomische Analyse," CSLE Discussion Paper Series 2004-03, Saarland University, CSLE - Center for the Study of Law and Economics.

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    More about this item

    Keywords

    guessing games; beauty contests; market failure; adverse selection; lemon problem; regulatory failure; paternalistic regulation;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • B4 - Schools of Economic Thought and Methodology - - Economic Methodology

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