The easiest way to answer this question is with a simple example. This experiment only takes a few minutes to run.
Guess a number between 0 and 100. You will be guessing this number with 72 other people. The guess closest to two-thirds of the average number wins. Ties will be broken randomly. Please write your guess down before scrolling down.
Here are the results run on second year microeconomics students at the University of Exeter.
The average was 36.68. Two-thirds the average was slightly under 24.5. The winning guess was 24. Were you a winner?
After showing them the results (of the previous year), these are the questions we discussed with students: Why did you write down your guess? If you thought everyone else was choosing their numbers randomly, what would you guess? If everyone thought the same as you, what would you guess? If everyone was rational, what should they guess (i.e. the equilibrium)? There were 6 guesses above 66.667. Does it ever make sense to guess above 67?
We then asked them to guess another number under the same rules. Before scrolling down, what do you think happened to the guesses?
The average was 12.4 (of which two-thirds is 8.3).
While we can show the unique equilibrium in this guessing game is 0, we saw that in the first iteration guesses were wildly off this. This deviation from equilibrium is typical. The game has been run numerous times (see Nagel, 1995; Camerer, 1997). At the Wharton School of Business, the average was 40, as it was among a group of CEOs. With Caltech undergraduates, the average was 30, unusually with 10% at 0 (too smart for their own good). For a group of economics PhDs, the average was 25. In the second iteration, things are always quite different and guesses are drastically lower. Thus, when the game is repeated equilibrium theory does much better.
So, what makes this an economic experiment? There is a clear prediction from economic theory that is tested by having students respond as the agents in a model.
From this game, one can clearly see the advantages of classroom experiments. The experiment is fun for the students to play. When a similar game was played by asking newspaper readers (Financial Times) to send in a guess (Nagel et al., 2002), there were thousands of responses. Even though the experiment is very simple, it generates plenty of discussion amongst the students. By playing the game, they also quickly grasp the concept of equilibrium and its prediction, far more easily than by explanations alone. Moreover, it teaches students to think about whether the models we teach them apply, and to see for themselves when they do or do not. As in this case, they often see both possibilities. As Colin Camerer (1997) puts it, ‘So game theory, which seemed so laughable at first, does predict what people will do with repetition. Again, psychology helps us understand what happens at first, and game theory tells us what will happen eventually as people learn. We need both to understand the entire picture.’