Knowledge that Transforms

Technical conditions give the entrepreneur a much freer hand about the acquisition of inputs (which are largely needed to start a new process) than about the completion of outputs (whose process of production-in the ordinary business sense-may be already begun). If forward markets consisted entirely of hedgers, there would always be a tendency for a planned weakness on the demand side; a smaller proportion of planned purchases than of planned sales would be covered by forward contracts. [1946, p. 137]

In two important studies, Charles Plott (1982) and Vernon Smith (1982) assess the current state of the literature about laboratory experiments in economics. As a profession, we are becoming aware that experimental methods can be applied to our models, with cautious but growing confidence that these procedures can help us evaluate alternative theories. These are significant developments whose potential ramifications are only beginning to be explored. Given the importance of laboratory testing, I would like to discuss a key feature of past experiments, one that has not been fully appreciated because of its central role in standard economic theory. In particular, these experiments depend on inducing agents to respond according to a prespecified value structure. This usually amounts to starting with a known and fully determinate set of demand and supply value schedules for all transacting agents. Smith, for example, specifies four major principles about how preferences are to be experimentally induced (nonsatiation, saliency, dominance, and privacy; see pp. 931-35).