Y. Durham J. of Economic Behavior Org. 42 2000 207–229 213
heshe sold a unit in both types of experiments. Price offers were restricted to being made in 5 peso increments to avoid a distortion in predictions stemming from this commission. The
only effect the commission had was to sharpen the prediction in the monopolymonopoly case. Because the theory predicts that the upstream firm will squeeze all of the profit out
of the downstream on the last unit, the commission provides an incentive to trade the last unit. Since prices could only be made in five peso increments, the upstream firm had no
way to extract the four peso commission from the downstream firm on the last unit. This is illustrated in Fig. 1. Marginal revenue equals marginal cost at 10 units for the upstream
firm. Upstream price would therefore be set at 410. Marginal cost for the downstream firm would be 410+100 or 510, causing marginal revenue to intersect marginal cost on the step
for the 10th unit. Therefore, the downstream firm would be indifferent between selling 9 units and 10 units. The 4 peso commission provides an incentive for the downstream firm
to sell this last unit, and the requirement that prices be in 5 peso increments prevents the upstream firm from extracting those 4 pesos from the downstream firm.
An exchange rate of 2.5 pesoscent was used for the monopolists in each experiment. An exchange rate of 0.25 pesoscent was used for the competitive firms since the competitive
firms were earning only commissions in equilibrium. In the monopolymonopoly exper- iments, the difference between downstream profits at the Nash prediction and the profits
at one unit below the prediction is only the 4 peso commission. The experiments were designed so that a subject’s indifference between choosing the predicted quantity and one
unit less would not involve a significant portion of the market. This, along with the linear demand curve, meant that the upstream monopolists in these markets would have earned
a great deal of money at the predicted prices. Using a large exchange rate would have flattened out the payoff function more than was felt suitable, so a lump sum payment was
taken from the upstream firm each period. Theoretically, this should not affect a subject’s maximizing choices. The lump sum payment was made small enough to allow for a wide
variety of choices and mistakes, so final payments to the monopolists still tended to be above average.
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3. Experimental procedures
Thirty-four undergraduates at the University of Arizona participated in these experi- ments. Four monopolycompetition and seven monopolymonopoly experiments were run.
Experiments generally lasted about one and a half hours for both types, and subject pay- ments averaged about 16.50 for the monopolycompetitive experiments and 28 for the
monopolymonopoly experiments. Each experiment consisted of two practice periods and 15 actual periods, and the subjects were informed of this at the beginning of each experi-
ment. The upstream firm was known as the producer, and the downstream firms were known as traders. Final buyers were simulated.
In the monopolycompetition experiments, subjects were brought into the room and told that one of them would have the opportunity to be a single seller, and that we would allow
them to earn the right to be that seller. Subjects were given a short trivia quiz, and the high
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Final payments to upstream monopolists ranged from 1.00 to 39.00.
214 Y. Durham J. of Economic Behavior Org. 42 2000 207–229
scorer was awarded the role of producer.
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Each subject was given a set of instructions and record sheets, a buyer demand schedule, and several offer forms. Copies of the instructions
for this experiment are available upon request. In this environment, the traders produced to order to avoid any problems associated with carrying inventories or exposing the traders
to risk. Each period, the producer was asked to set a price, which the traders were shown immediately. The traders were then invited to submit a contingent price to the buyers. The
buyers, who were programmed following the buyer demand schedule, ordered from the traders, given the set of offered prices. The buyers were ordered randomly each period and
programmed to approach the low-priced trader first, and in the case of a tie, to randomly choose a trader to deal with. The buyers were programmed this way in order to more
closely approximate reality. Because of the competitiveness of these downstream markets, ordering the buyers randomly never reduced the efficiency of the markets. The orders were
submitted to the traders, after which the traders made purchase requests from the producer. If the producer did not offer to supply enough units to satisfy the traders, the traders’
purchase requests were processed in a random order which the traders were informed of at the beginning of each period. In each experiment, one subject was paid a fixed payment
of 15 to run papers back and forth between the subjects and the experimenter to speed processing.
In the monopolymonopoly experiments, subjects were brought in one pair at a time and randomly assigned the roles of producer and trader. Since subjects were face to face
in the monopolycompetition experiments, these experiments were conducted face to face also. An asymmetry of information existed because the producer had enough information
to calculate the maximum profit that the trader could earn given each price the producer offered, but the trader had enough information to be able to compute only his own profit.
Each period, the producer was asked to post a price which was shown to the trader. The trader then offered a price to the buyers, and knowing the quantity demanded at that price,
made hisher purchasing decision.
4. Results
