A Free Entry and Exit Experiment

Abstract

In this article, I describe an experiment that demonstrates the dynamic process that leads to long-run equilibrium in a multimarket setting. In the experiment, each student plays the part of a farmer who has to decide each period whether to supply one unit of corn, wheat, rice, or soybeans. It costs different amounts to produce each of the crops, and the prices of the crops depend on the amount supplied and consumer demand. There are no consumers in the experiment. Demand is determined from prespecified inverse demand curves that are unknown to the participants.' Students are instructed to act as profit maximizers. The goal is to see how free entry and exit lead to equal profits across markets in the long run, and how opportunity costs determine what those profits are. In addition, some subtle aspects of the process that leads to long-run equilibrium are revealed. The experiment has two stages. In each round of the first stage, students decide which one of the four markets to enter. The opportunity cost of farming is zero, and long-run equilibrium has zero accounting profits in each market. In the second stage, the government introduces a fallow program whereby it guarantees any farmer a profit of one dollar if he or she does not plant a crop. The fallow program increases the opportunity cost of farming to one dollar and makes that the equilibrium level of accounting profits. Market experiments such as the double oral-auction experiment introduced by Smith (1962) are often run in economics classes (Wells 1991; DeYoung 1993). Such experiments focus on how competitive markets clear and on the efficiency of competitive equilibrium. The experiment discussed here is a natural follow-up to the double oral auction. It should be conducted after economic profits have been defined and the short- and long-run profitability of firms in competitive markets has been discussed.

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