Laboratory experimental methods began at Caltech in the early 1970's when Professor Charles R. Plott, Edward S. Harkness of Professor of Economics and Political Science, discovered a methodology for applying laboratory methods to the study of public economics. The methodology, which was related to the experimental methods used earlier by Vernon Smith to study market behavior, opened the way for an experimental examination of public goods and the impact of different institutions that might be implemented for the provision of public goods. The initial research, with Morris Firoina, lead, immediately, to the discovery that collective decision processes, such as majority rule, when applied to the provision of economic public goods, exhibit an equilibration process. Furthermore, the equilibration process can be modeled by principles of equilibrium (majority rule equilibrium) and game theory (the core of a cooperative game without side payments). Additional research with agendas established that the principles governing public actions are more fundamental than are captured by the straight forward application of game theory and voting equilibrium models because the decisions could be almost completely determined by institutional controls (the agenda). This prominence of institutional influences on decision processes together with the close relationship between institutional influences and associated theory, continue as a dominating theme of research even today.
Research in public economics began to merge with research in classical economics when Plott invited Vernon Smith to visit Caltech as a Sherman Fairchild Fellow. During this period Plott and Smith initiated the first systematic study of competitive market experiments since Smith had studied markets in the early 1960s. From the early 1960's until the new research at Caltech in the 1970s no more than paper or two dealing with competitive markets and an additional two or three papers on oligopoly were published. Plott and Smith joined in teaching the first course in experimental economics at Caltech and from their efforts came three discoveries that set the stage for a revolution in experimental methodology. The first was the posted price effect, which elevated the importance of institutions as a key focus of research in market economics. Early research on the importance of institutions in markets (different auction processes) and the importance of institutions found public economics were now supplemented with a third area. However, the posted price effect was especially important. It had a potential for applications much beyond the other experimental findings because of its connection to industrial organization and policy. The second was the discovery and development of an efficiency measure that could be applied to assess the efficiency of institutions implemented in experimental markets in exactly the same way that cost benefit analysis is used to assess the efficiency of naturally occurring markets. The posted price effect and the efficiency measure established a laboratory scientific window for the first attempts to use laboratory economics in an active policy context. The third discovery of the very early 1970's, with Ross Miller, was that speculation could be studied in experimental markets and that speculative activity could be observed equilibrating markets along the lines of classical theory.
From this background the modern experimental methods in economics began to grow. The research expanded to include many different types of institutions, uncertainty and information. The attempts to apply laboratory experimental methods to policy problems became systematic. Two major policy studies, which were published only several years after the actual research, were an application to posted prices found in the inland water transportation industry (Plott and Hong) and an examination of the method for allocating the rights to land at the major airlines (M. Issac, D. Grether and C. Plott). To these were added the first studies of the role of asymmetric information in markets. The convergence properties of multiple markets were discovered. Conspiracy, price controls and other types of market interventions were examined experimentally for the first time. New forms of markets were studied, such as methods for deciding on programs for public broadcasting. The theory of agendas and public decision making was applied to the analysis of defense problems where committees were thought to make decisions. Classic papers on individual choice, such as the preference reversal phenomena were also produced. During this time many now famous names, J. Ferejohn, R. Forsythe, Dave Grether, E. Hoffman, M. Isaac, G. Miller, R. Noll, and T. Palfrey all became interested in laboratory experimental methods. In the late 1970s Dick McKelvey and Peter Ordeshook, both of whom had active interests in experiments with many contributions, joined the faculty. Caltech had become famous for its contributions to laboratory methods in economics and political science.
In the mid 1980s the Division Chairman, David Grether provided space in Baxter Hall for a new laboratory. Plott, the director, and raised funds for the creation of a laboratory from General Motors Corporation, the Lynde and Harry Bradley Foundation, Pacific Bell, Inc. and the National Science Foundation. Basic research began immediately and, in addition, a grant to the Jet Propulsion Laboratory to study the allocation of resources on Space Station Freedom focused efforts on the creation of computerized experiments. The first local area computerized markets (MUDA) were created by Hsing-Yang Lee according to the specifications defined by Plott and Caltech's Laboratory for Experimental Economics and Political Science was born in its current form.
From the origin of the Caltech Laboratory the economics profession
has experienced an explosion of the applications of laboratory experimental
methods. Volumes of experimental papers are being published each
year and the number of laboratories is rapidly growing around the world.
The Caltech Laboratory is a major facility that is serving as a model for
laboratory development throughout the world. Knowledge about the
potential uses and limitations of experimental methods has been an important
tool for Caltech graduate students in launching their careers.