When Vicious Circles May Turn Virtuous: An Experiment on a Circular Cobweb Economy

Abstract

In this paper we try to neutralize the strategic behaviour commonly observed in experimental cobweb markets (Sutan and Willinger, 2002, 2003) in order to restore the coherence of the production decisions and price forecasts. This is done by introducing into the experimental design a circularity operator by which each subject has to make a guess about the price determined by the production decisions of all other agents in the market (except himself). With this procedure we eliminate market power, by generating a situation of local asymmetrical interaction : each agent i acts as a price-taker on his own market while the n-1 remaining players are price-makers. However, from a global point of view, all the subjects are inter-connected, and therefore are perfectly symmetric. Each subject assumes fundamentally two roles : he acts as a price-taker on his own product market since his production decision does not affect his own price, but he acts as a price-maker on the other players' markets, since his production decision affects other players' selling price. Such circular links between agents can be vicious, because if a single agent adopts a risky behaviour, he drives all markets in which he is involved in the same direction. However, we make the assumption that circularity could eliminate the non-coherent behaviours and transform the producers into real price-takers (it becomes virtuous). This assumption is tested experimentally. We show that: i) prices are stationary around the rational expectations equilibrium; ii) subjects do not exhibit strategic behaviour even in the first part of the experiment; iii) the subjects' forecasts come very close to the equilibrium; iv) price series on various markets are correlated; v) over time, the participants take into account the prices and their individual production when they form their forecasts, which testifies of their ability of sophistication and comprehension of the interactions of the economy.

Keywords: cobweb, vicious circles, eductive reasoning

JEL Classification: C91