A market is a social system where buyers and sellers exchange goods and services. A “free market” is one where anyone can buy or sell from or to anyone. Given the nature of independent buyers and sellers there is a “perfect competition” between each seller and each buyer. Sellers will want to make a profit and buyers will want to purchase the goods or services at an optimal pricing. If they all had “perfect information” the market would be at an efficient equilibrium where all the goods and services would be at a fair price. If the agents are rational and would like to maximize utility, they buy low, and sell high.
Real markets however, are not free or perfect. Government regulations in the form of taxes, regulations, standardization, monopoly, monopsony, incomplete information, black box trading, non-rational behavior etc contribute to a a volatile, non-efficient, real market. Agents in a market cannot find an equilibrium (micro issue) in every market, with different markets, interest rates (macro issue). Oversimplified, Adam Smith’s Invisible Hand postulated that everyone acting in their self interest will bring the system to an equilibrium.
The Zero Intelligence Trader model (or the Zero Knowledge Trader model) works on Dhananjay K. Gode and Shyam Sunder’s the principles of bid-asked-price-reduction-rule. A bunch of buyers and sellers without the knowledge of each other’s price values would trade among each other until the demand-supply curve reached an equilibrium.
The Zero Intelligence Plus Trader model modified the system to have buyers and sellers slightly more knowledge-able. A learning curve was introduced to have each individual maximize their profit margin. The learning curve emulates how everyone in a trade house shouts out their price points such that people around them know their values. This is made even simpler with electronic trading possibilities. Variations include English auction style, Dutch auction style, and Continuous Double Auction.
Zero Intelligence Plus traders have been used to investigate:
Sealed-bid auctions (Bagnall and Toft (2004, 2005))
Market behavior with incomplete flows of information and trade (Ladley and Bullock (2006)
NetLogo Model of Zero Intelligence Trader Model
1. Hit the SETUP command multiple times. Each time you do it buyer agents are randomly assigned new values and sellers new costs. The demand curve is always downward sloping and the supply curve is always upward sloping. Why do the curves vary as they do from SETUP to SETUP?
In the Zero Intelligence Trader model, demand and supply are made of induced values. The random values for “Price” and “Quantity” of goods sold and bought by sellers and buyers respectively. On implementing efficient trading, valuations are moved around between buyers and sellers, including profits to accommodate all the values within one model. The downward demand slope and upward supply curve vary with each SETUP because of the randomness of the values, and their accommodation within the model each time.
2. Now run the model (press GO). What is the total quantity sold, and what is the average price? Hit SETUP and GO multiple times, keeping track of the (quantity, price) pairs that result. What is the typical price and quantity?
Typical Quantity = 24.8
Typical Price = 99.478
3. As you increase the number of buyers what happens to the demand curve? What happens to prices and quantities sold?
New numberOfBuyers = 100
Typical Quantity for 100 buyers = 37
Typical Price for 100 buyers = 122.99
New1 numberOfBuyers = 200
Typical Quantity for 200 buyers = 43.4
Typical Price for 200 buyers = 140.994
The demand curve is downward sloping even as the supply curve ended, that is, demand for a good fell consistently even as supply was constant.
For more number of buyers, the typical quantity and price reduced.
4. As you decrease the maximum buyer value what happens to prices and quantities?
maxBuyerValue = 100
With reduced maximum buyer value, prices increase while typical quantity drops.
5. No agent in this model knows anything at all about the overall supply and demand curves, the values or costs of its trade partners, or how the market will unfold. Yet the ‘typical’ behavior of the market comports, broadly, with the usual supply and demand story taught to undergraduates. How is this possible?
The agents have no knowledge of the bigger picture in the model yet the model works much like its real world counterpart because the market is driven by buyers. The constraints in the system act as the “invisible hand” from Adam Smith’s The Theory of Moral Sentiments wherein an individual’s self interests have a direct impact on the social benefits in that system.
6. The main way in which the model results depart from the standard conception of neoclassical markets is that the standard deviation in prices does not decline as the size of the model increases (demonstrate this). What is responsible for the persistence of price dispersion (non-zero price variance). How might you modify the agents so that there would be less price dispersion?
Price dispersion is the variation in highest and lowest prices between different sellers for the same goods. One of the ways to reduce price dispersion, is to reduce the number of sellers. Potentially, reducing the search cost will also reduce price dispersion. Search cost is the amount of time a buyer will spend looking up alternatives for a good at lower cost to compare the prices between sellers. When the buyers care more about the time cost than the monetary costs, sellers might sell their goods at uniform prices, reducing price dispersion.