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Vernon Smith, Economic Experiments, and the Visible Hand : Don Coursey
4 paragraphs found.

Economic theory in its simplest incarnation of supply and demand makes a strong set of predictions. What are the supply and demand schedules here? Consider an axis set that has price on the vertical axis and quantity on the horizontal axis. The supply schedule answers the question "How many units would voluntarily be brought to the market at different prices?" Thus supply in this experimental structure is an ascending stair-step pattern that starts at $10 and rises $2 per step for each unit in the market. Above $18 the supply curve is vertical for no other than the fifth unit can ever be purchased in this setting. Likewise, the demand schedule answers the question "How many units will be voluntarily purchased in the market at different prices?" Using the same analysis as that for the sellers, we find that the demand schedule is a descending stair-step pattern that starts at $22 and falls $2 per step for each unit demanded in the market. Below a price of $14 the demand schedule also is vertical for no more than the five units are desired in this setting. For this scenario, textbook economics predicts that equilibrium will be reached where supply equals demand. In this case that means that four units would be traded at the identical price of $16.


At certain times of the day at large American cities more jets want to land and depart than can be handled by the airport. Demand for take-offs and landings exceed supply capacity during these periods. One obvious economic solution to this problem is to auction off the right to land and take off during the congested periods; to take the fixed number of scarce "slots" during this period and sell them to the highest bidders. This logic is correct. But Smith realized that it was incomplete. The problem is not just the fact that you want to land at O'Hare airport in Chicago on Friday in the 4:00 through 5:00 P.M. time slot. Typically you want other side conditions to be met. You might also want a slot out of O'Hare between 6:00 and 7:00 P.M. Additionally you may be flying from Chicago to another congested airport like Atlanta, so you will want a landing slot there as well and so on.


At its essence, slot allocation is a problem of balancing supply and demand. But the constraints associated with so many crowded, interconnected airports with so many airlines and aircraft competing for space make the simple problem seem impossibly complex. Smith did not think so. He was able to develop a system of combined auctions that solve this problem. These auctions were exhaustively tested in his laboratory and are now used as allocation tools in national airport management.


Electricity has three properties that make it different from other economic commodities. First, it is the only product where supply and demand have to be equal at all moments in time. Electricity suppliers promise to meet the use by demanders—when you switch on your lights, you expect them to come on. Second, electricity is hard to store. Third, electricity does not really move directly from its source to its ultimate user. Rather, when electricity is provided to a power grid, it is better to think of the grid as a great pond whose water level has just increased. These three factors have inhibited the trading of electricity across regions in this country. Smith, always on the lookout for market solutions that could improve efficiency cracked the complex technical problems associated with how to trade something so seemingly amorphous as electricity. His work in this area provided the basis for a radical new system of electricity and energy trading that swept the country during the 1990s. Smith advocated an open trading system for electricity in both the wholesale and retail markets. States that have adopted his system fully have benefited greatly. Other states that still use old regulatory regimes or, like California, only applied a partial market framework have struggled.