Experimental Economics at University of Malaya

Today, experimental economics is widely recognized as an important sub-discipline in economics. The ultimate recognition of the importance of experimental economics came when one half of the 2002 Nobel Prize in economics was awarded to one of the pioneers of experimental economics, Professor Vernon Smith from George Mason University. Professor Smith was a student of the renowned Harvard economist, Edward Chamberlin who, in the 1940s, conducted one of the earliest published experiments in economics.*

The Nobel citation for Professor Smith reads as follows:

"for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms"


Having being fascinated by experimental economics for a long time, I finally mustered enough courage to conduct a small experiment in my class yesterday. My main motivation (aside from my own curiosity) was to expose my students to experimental economics. I attempted to replicate a trading game described in detail by Professor Charles Holt.** The game simulates a trading process in a pit market. In the experiment, each buyer or seller is given a poker card randomly. Buyers are given cards with either the diamond or heart (RED) symbol while sellers are given cards with the spade or club symbol (BLACK). The number printed on a buyer's card represents his/her valuation of a hypothetical good to be purchased. The number on the seller's card represents the seller's cost. Buyers are not permitted to pay more than their valuation of the goods while sellers are not permitted to sell at prices below their cost levels.

Forty students participated in the experiment. Due to time constraint, we only had time to conduct eight rounds of trading. Students assume the same role (seller or buyer) throughout the first seven rounds. In the eighth round the roles were reversed.

The results from the experiment were stunning. Our theoretical prediction for the equilibrium price is RM5.50 (Figure 1).


The transaction prices were fairly dispersed at the beginning of the trading rounds. However, by the sixth round of trading most of the transaction prices had converged to RM5.50 (Figure 2).

The experience of conducting this little experiment is certainly one of the most exciting moment in my teaching career. Judging from the animated haggling by the students during the experiment, I am sure many of them found this experience to be a fun way to learn economics or experimental economics.

I will certainly look for opportunities to conduct more experiments in my future lectures!


* Chamberlin, Edward. (1948). "An Experimental Imperfect Market", Journal of Political Economy, Vol.56, pp.95-108.

**Holt, Charles. (1996). "Classroom Games: Trading in a Pit Market", Journal of Economic Perspectives, Vol.10, No.1, pp.193-203.

3G Spectrum License Award: A Flawed Exercise

On 3 March 2006, two additonal 3G licenses were awarded to Malaysian companies. What was surprising was that one of the incumbent operators in the mobile telephony market, DIGI, missed the boat. Subsequent to this, speculation was rife in the media that DIGI was denied a 3G license due to the fact that it is considered to be a foreign company. This was subsequently confirmed by the Minister of Energy, Water and Communications in media reports published on 12 March 2006. The reason given by the Minister was that "3G spectrum is a scarce national resource and preference should be given to local companies".

The Ministry's decision and the subsequent revelation of the underlying reason for this decision is puzzling indeed. If resources are scarce, then the government should have seriously considered using a beauty contest to screen for qualified applicants and then subsequently hold an auction of the licenses. This would have guaranteed that the companies that value such licenses most would obtain these licenses. The government would also have maximized the revenues it can obtain from the selling of 3G licenses. This would ultimately result in the efficient allocation of scarce resources such as the 3G spectrum.

An alternative and likely interpretation is that the government approached the problem in a nationalistic manner. This line of reasoning implies that the rents from owning 3G licenses should accrue to Malaysians or Malaysian companies. The two beneficieries are different. Selling scarce recources to private companies at prices that are below market value (as some analysts seem to suggest) do not necessarily benefit the Malaysian society. Rents from such a sale will accrue to only shareholders of these companies which constitute a minority segment of the Malaysian society. What would have been a better 'nationalistic' solution is for the government to extract maximum revenues from the sale of the licenses and redistribute it to the average Malaysian citizen via its fiscal policy.

A nationalistic approach to the problem also does not make much sense if Malaysia is interested to upgrade the competitiveness of its services sector and economy. This can only be achieved if we encourage Malaysian-owned companies to compete with foreign companies in markets abroad as well as in the domestic market. The past suggests that DIGI provides a healthy dose of competition in the Malaysian mobile telephony market. A pioneer in pre-paid mobile telephony subscriptions, it has recently embarked on innovative pricing strategies in the market. Of course, the Minister has argued that "DiGi can still be involved by renting the 3G spectrum or buying into the companies". However, this is not the same as direct ownership of the licenses. Renting the spectrum from other companies is likely to raise its costs above that of its competitors. Buying into another company that owns a 3G license would result in DIGI paying a substantial market price - presumably, a price that would have prevailed in an auction plus a mark-up. Furthermore, even if a nationalistic approach is adopted for whatever reason, surely we can allow one foreign company to compete against four other Malaysian companies on a level-playing field basis, at least for the benefit of the consumers and for the long-term development of the sector.

Making Sense of Fuel Subsidy Reduction in Malaysia

On 28 February 2006, the Malaysian government announced the reduction of fuel subsidy by 30 sen. For many Malaysians, this announcement was a shocking news. The official reason for the reduction of subsidy given was that the money saved (RM4.4 billion) would be used to fund improvements in the country's public transportation system.

My immediate impression of the statement was that the money saved would be spent on development expenditures for the next five years. The five-year development plan, the Ninth Malaysia Plan (9MP), should be out by month. At this stage, I am sure officials from the Economic Planning Unit, Prime Minister's Department, would have computed the total development expenditures for the next five years. This could pose some problems to the government's effort to achieve a balance budget, a policy it announced a few years ago. In other words, the government savings from subsidy reduction would come in handy for 9MP expenditures. Hence, the government's reason for the subsidy reduction may imply that a the transport sector will be a key focus area in the 9MP. Alternatively, it could mean that the governemnt would find it difficult to balance its budget in the next five years without the fuel subsidy reduction.

There are many arguments why it makes sense to reduce fuel subsidies. One argument whch is attractive from an economics point of view but may not be fully appreciated by the general public is that any reduction of fuel subsidy tantamounts to reduction in the distortion of allocation of scarce resources (fuel, in this case). This implies that people would use an optimal amount of fuel if fuel prices accurately reflect their scarcity. If we take into account the impact of fuel consumption on the environment (externalities, pollution), we should even consider imposing additional taxes on petrol consumption.

The government has also repeatedly stressed that the fuel subsidy reduction would not burden the lower income groups as only the wealthier segment of society would be affected. This is probably not 100 percent true. Our society is not divided into two classes - poor and rich. I think the middle class and the poor will bear the brunt of the reduction in fuel subsidy. The poor would include those currently using motorcycles for work especially in the rural areas. There may not be sufficient transport alternatives in this sector. Unless the government can guarantee the current public transportation system is improved quickly and sustainably, the cost borne by the poor and middle class could be significant. This would include the increased travel time incurred by the poor and middle class who are now 'forced' to use an inefficient public transportation system. Ideally, the government should have guaranteed an improved public transportation system BEFORE it decides the reduce fuel subsidy. In other words, if you force people to use the public transportation system, you must at least guarantee that the supply of such services is adequate and of acceptable quality. Furthermore, as our previous investments in this sector indicates, large investments do not always guarantee that we will have an efficient transportation system. Good regulation including the placement of appropriate incentive systems for private sector participation is important.