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Fairness, Errors and the Power of Competition

Listed author(s):
  • Urs Fischbacher
  • Christina M. Fong
  • Ernst Fehr

One of the most basic questions in economics concerns the effects of competition on market prices. We show that the neglect of both fairness concerns and decision errors prevents a satisfactory understanding of how competition affects prices. We conducted experiments which demonstrate that the introduction of even a very small amount of competition to a bilateral exchange situation � by adding just one competitor � induces large behavioral changes among buyers and sellers, causing large changes in market prices. Models that assume that all people are self-interested and fully rational fail to explain these changes satisfactorily. In contrast, a model that combines heterogeneous fairness concerns with decision errors predicts all comparative static effects of changes in competition correctly. Moreover, the combined model enables us to predict the entire distribution of prices in many different competitive situations remarkably well.

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Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 133.

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Handle: RePEc:zur:iewwpx:133
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  8. Ernst Fehr & Armin Falk, 2003. "Wage Rigidity in a Competitive Incomplete Contract Market," Labor and Demography 0305001, EconWPA.
  9. Dufwenberg, M. & Kirchsteiger, G., 1998. "A Theory of Sequential Reciprocity," Discussion Paper 1998-37, Tilburg University, Center for Economic Research.
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  14. Roth, Alvin E. & Vesna Prasnikar & Masahiro Okuno-Fujiwara & Shmuel Zamir, 1991. "Bargaining and Market Behavior in Jerusalem, Ljubljana, Pittsburgh, and Tokyo: An Experimental Study," American Economic Review, American Economic Association, vol. 81(5), pages 1068-1095, December.
  15. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer;Economic Science Association, vol. 10(2), pages 171-178, June.
  16. Guth, Werner & Schmittberger, Rolf & Schwarze, Bernd, 1982. "An experimental analysis of ultimatum bargaining," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 367-388, December.
  17. Fehr, Ernst & Schmidt, Klaus M., 1999. "A theory of fairness, competition, and cooperation," Munich Reprints in Economics 20650, University of Munich, Department of Economics.
  18. David K Levine, 1997. "Modeling Altruism and Spitefulness in Experiments," Levine's Working Paper Archive 2047, David K. Levine.
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  22. Axel Ockenfels & Gary E. Bolton, 2000. "ERC: A Theory of Equity, Reciprocity, and Competition," American Economic Review, American Economic Association, vol. 90(1), pages 166-193, March.
  23. Fehr, Ernst & Schmidt, Klaus M., 2001. "Theories of Fairness and Reciprocity," Discussion Papers in Economics 14, University of Munich, Department of Economics.
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