The Nobel Prize

Vernon L. Smith (b. 1927)

Vernon Smith was born in Wichita, Kansas, USA in 1927. He was awarded a BS in electrical engineering by the California Institute of Technology (Caltech) in 1949. As an undergraduate, Smith recalls attending lectures given by visiting scholars such as Robert Oppenheimer and Bertrand Russell. His interest in economics was stimulated by a course he took in the subject at Caltech. Wider reading acquainted Smith with a number of different approaches to economics, some of which complemented the methodologies of physics and engineering with which he was already familiar. To discover whether or not he might have a career appetite for economics, Smith returned to Kansas and studied for a master’s degree. He was awarded an MA in economics by the University of Kansas in 1952. In his Nobel Memorial Prize autobiographical notes, Smith remembers being particularly influenced by a course in the development of economic thought taken as part of his master’s programme. The material he encountered allowed him ‘to acquire knowledge of all the supporting structure, tools and primary sources of inspiration’ in economics (Nobel Foundation, 2004). Smith’s commitment to the discipline was by now confirmed and he moved to Harvard University, completing a PhD in 1955. Here he was taught by, among others, Alvin Hansen and Wassily Leontief; he also took courses from Paul Samuelson at nearby Massachusetts Institute of Technology.

Smith’s first teaching post after leaving Harvard was in Indiana at Purdue University, where he remained until 1967. At Purdue he was assistant professor (1955–56), associate professor (1957–59) and professor (from 1961). In 1961–62 he was visiting associate professor at Stanford University. In 1967, Smith took up a professorship at Brown University, leaving the following year for a similar post at the University of Massachusetts where he worked until 1975. From 1974–75, Smith was visiting professor at Caltech. In 1975 he moved to the University of Arizona at Tucson as Regents’ Professor of Economics. Since 2001 Smith has been Professor of Economics and Law at George Mason University, Arlington, Virginia.

Smith’s awards and distinctions include past presidencies of the Public Choice Society, the Economic Science Association and the Western Economic Association. He has been a Sherman Fairchild Distinguished Scholar at Caltech, a Ford Foundation fellow and a fellow of the Center for Advanced Study in the Behavioural Sciences. He is a fellow of the Econometric Society, the American Association for the Advancement of Science and the American Academy of Arts and Sciences. In 2002, Smith was awarded the Nobel Memorial Prize in Economics ‘for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms’ (Nobel Foundation, 2004).

In his first teaching post at Purdue University, Smith ‘found it a challenge to convey basic microeconomic theory to students. Why/ how could any market approximate a competitive equilibrium?’ (Nobel Foundation, 2004). While at Harvard, Smith had participated in E.H. Chamberlin’s class-based experimental demonstration that markets need not produce the equilibrium outcomes predicted by economic theory because they are imperfectly structured. Chamberlin assigned buyer and seller roles to students in class to produce his results. This method proved to be Smith’s inspiration but he modified it for use at Purdue in two important ways: first, he refined the institutional setting to make it more open and competitive and, second, he allowed for several successive ‘trading days’, so that participants could learn from their experiences in the experimental marketplace.

Smith found his results quite staggering: instead of confirming Chamberlin’s work, they contradicted it. Equilibrium rapidly emerged  in accordance with the strictures of price theory and this continued to happen regardless of nuances in the design of the basic experiment. Even when the number of agents was limited to single figures, equilibrium was still reached. Smith had certainly found a powerful means to illustrate the simple elegance of the market mechanism to his students. Getting his work accepted by his peers proved a rather more difficult proposition. These early experiments were eventually reported in a paper in the Journal of Political Economy (Smith, 1962), though only ‘after two revisions, four negative referee reports and an initial rejection’ (Nobel Foundation, 2004). Even economists who will one day win the Nobel Memorial Prize sometimes have it tough.

Further experiments investigated the influence of actual financial rewards on the behaviour of student subjects as economic agents. Smith found that paying subjects according to their ‘success’ in the marketplace was a powerful means of ensuring that their motives reflected those the investigator was trying to reproduce. He also discovered that the greater the reward, the faster the emergence of ‘rational’ behaviour among subjects (Smith, 1964).

Smith’s growing interest and expertise led him to offer a graduate seminar in economic experimentation at Purdue starting in 1963. His lecture notes from this period would later form the basis of a paper in the American Economic Review on induced valuation (Smith, 1976a). The Nobel Memorial citation for Smith declares that this paper as ‘a practical and detailed guide to the design of economic experiments in the laboratory and a motivation for these guidelines … serves as a paradigm for experimental scholars in economics’ (Nobel Foundation, 2004).

In collaboration with others, Smith demonstrated that the institutional form assumed by a market may have an important bearing on the way it functions (see, for example, Plott and Smith, 1978; Smith and Williams, 1981). This confirmed the implication from Smith’s earlier refinement of Chamberlin’s original model that the design of a market could be tested and improved in the laboratory. Experiments clearly facilitate forms of research in economics that cannot be accomplished by the observation of field data from actual markets. One further application of this approach by Smith has been to test the efficiency of alternative designs for public goods delivery mechanisms (see, for example, Smith, 1980a).

Smith’s Nobel Memorial citation includes specific reference to his work on auctions (Nobel Foundation, 2004). Although auctions have recently become big business, sometimes yielding immense sums to governments if not the economists advising them (see Binmore and Klemperer, 2002), Smith has been applying the methodology of experimental economics to auction theory for a long time (see, for example, Smith, 1965). With colleagues, he has uncovered a series of regularities associated with different auction forms (see, for example, Smith, 1976b; Coppinger et al., 1980b).

In his highly stimulating Nobel Memorial Prize Lecture, Smith employs a distinction between ‘constructivist’ and ‘ecological’ rationality to help explain the significance of experimental economics. Constructivism embraces the familiar perfectly knowledgeable rational agent who is situated in an institutional context suited to his or her capacities and motivations. But this conceptualisation is ‘unlikely to approximate the level of ignorance that has conditioned either individual behaviour, or our evolved institutions’ (Smith, 2003, p. 506). In contrast, following Adam Smith, ecological rationality understands economic behaviour and institutional forms to possess a social-grown and multiply-determined ‘emergent order’. Agents need not be all-knowing or consistently act in an immediately self-interested fashion; nor must institutions be immediately fully formed and complete: economic order and progress still happens. Smith argues that experimental economics can bridge the gap between these two interpretations of rationality. For example, designs for economic systems or institutions might be produced using constructivist rationality: we propose what we think might work. It then becomes possible to mirror the process of an emergent order by employing the methodology of experimental economics to test, modify and rework these designs. This use of the laboratory as a design ‘wind tunnel’ is also highlighted in Smith’s Nobel Memorial citation.

In addition to his pioneering work in experimental economics, Smith has also made important contributions to a number of other areas including: the theory of investment and production (see, for example, Smith, 1959; 1961) and natural resource economics (see, for example, Smith 1968; 1971; 1975). For a collection of key papers in experimental economics the reader is referred to Smith (1979; 1982; 1985; 1991).

Main Published Works
(1959), ‘The Theory of Investment and Production’, Quarterly Journal of Economics, 73, February, pp. 61–87.
(1961), Investment and Production, Cambridge, MA: Harvard University Press.
(1962), ‘An Experimental Study of Competitive Market Behaviour’, Journal of Political Economy, 70, April, pp. 111–37.
(1964), ‘Effect of Market Organization on Economic Behaviour’, Quarterly Journal of Economics, 87, May, pp. 181–203.
(1965), ‘Experimental Auction Markets and the Walrasian Hypothesis’, Journal of Political Economy, 73, August, pp. 387–93.
(1968), ‘Economics of Production from Natural Resources’, American Economic Review, 58, June, pp. 409–31.
(1971), Economics of Natural and Environmental Economics, New York: Gordon & Breach.
(1975), ‘Economics of the Primitive Hunter Culture with Application to Pleistocene Extinction and the Rise of Agriculture’, Journal of Political Economy, 83, July–August, pp. 727–55.
(1976a), ‘Experimental Economics: Induced Value Theory’, American Economic Review, 66, May, pp. 274–9.
(1976b), ‘Bidding and Auctioning Institutions: Experimental Results’, in Y. Amihud (ed.), Bidding and Auctioning for Procurement and Allocation, New York: New York University Press.
(1978), ‘An Experimental Examination of Two Exchange Institutions’ (with C. Plott), Review of Economic Studies, 45, February, pp. 133–53.
(1979), Research in Experimental Economics, vol. 1 (ed.), Greenwich, CT: JAI Press.
(1980a), ‘Experiments with a Decentralised Mechanism for Public Goods Decisions’, American Economic Review, 70, September, pp. 584–99.
(1980b), ‘Incentives and Behaviour in English, Dutch, and Sealed-Bid Auctions’ (with V.M. Coppinger and J.A. Titus), Economic Enquiry, 18, pp. 1–18.
(1981), ‘On Nonbinding Price Controls in a Competitive Market’ (with A.W. Williams), American Economic Review, 71, June, pp. 467–74.
(1982), Research in Experimental Economics, vol. 2 (ed.), Greenwich, CT: JAI Press.
(1985), Research in Experimental Economics, vol. 3 (ed.), Greenwich, CT: JAI Press.
(1991), Papers in Experimental Economics, New York and Melbourne: Cambridge University Press.
(2003), ‘Constructivist and Ecological Rationality in Economics’, American Economic Review, 93, June, pp. 465–508.

Secondary Literature
Bergstrom, T.C. (2003), ‘Vernon Smith’s Insomnia and the Dawn of Economics as Experimental Science’, Scandinavian Journal of Economics, 105 (2), pp. 181–205.
Binmore, K. and P. Klemperer (2002), ‘The Biggest Auction Ever: The Sale of the British 3G Telecom Licenses’, Economic Journal, 112, March, C74–C96.
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