Instability of Equilibria in Experimental Markets: Upward-Sloping Demands, Externalities, and Fad-Like Incentives

Abstract

The objective of the paper is to study markets in which the value of the activity to any one person increases with the level with which the activity is undertaken by others. The general interpretation could be fads, mimicking behavior, or some sort of belief formation process in which the beliefs or expectations of agents about some underlying state of nature are influenced by the buying behavior of other agents. The result is to create a market that can be modeled as having an upward-sloping market demand curve. The questions posed are (1) in the fad-like environment, does the classical concept of equilibrium (as an equating of market demand and market supply) accurately predict market behavior; (ii) can both stable and unstable equilibria be observed; and (iii) which of the two classical concepts of stability best describes the conditions under which instability is obeserved? Under the conditions of a fad-like demand side externality in a market organized by the multiple unit double auction (MUDA), market equilibration occurs at a point where demand equals supply. The disequilibrium behavior follows the dynamics of the Marshallian model of dynamics, as opposed to the Walrasian model. These results confirm and extend the major findings of Plott and George who studied a similar environment with a downward-sloping supply.