Rational Expectations Experiment

Peterson, Norris A. "A Rational Expectations Experiment." Journal of Economic Education. 21 (Winter 1990) 73-78.

This experiment demonstrates the major elements of the rational expectations theory. It requires six student teams, designated A through F, to act as price-taking producers who must make supply decisions based on imperfect information. Each team needs a spokesperson, who should receive a set of three cards, marked with a large "+", "-", and "0" respectively, representing the team’s choice of supply increase, decrease, or no change. To begin, handouts 1 and 2 are distributed, which inform teams of rules and the team’s period 9 price increase. If the team believes that its price increase is below average, it should cut back production; if it thinks its price is just at the average, it should expand; if it thinks its price is just at the average, it should maintain its current output. Each team takes a couple of minutes to come to a decision, and then each spokesperson reveals to the class the card chosen. The instructor records the decisions, which indicate if aggregate output has changed and in what direction. The average price increase should also be reported. This is repeated for round 10. In period 11, inflation unexpectedly increases. The game is continued through period 15, through which prices and inflation are varied. Discussion follows.