A Simple Economic Teaching Experiment on the Hold-Up Problem

Abstract

The hold-up problem is central to the theory of incomplete contracts. This can occur if, after making a sunk investment in a relationship, one party can be taken advantage of by the other party, leading to inefficient underinvestment. The authors describe a simple teaching experiment that illustrates the hold-up problem, and address how to integrate it into a class.

Keywords:

• classroom experiments
• hold-up problem
• subgame perfection

JEL codes:

• C9
• G34
• L14

Acknowledgments

The authors thank HEFCE for financial support, John Sloman and the rest of the Economics Network for feedback on the experimental design, David Kelsey for providing an initial set of students, and Marc Hodes and Jörg Hahn for describing the software used for aerodynamic design in the auto industry. They also thank Dudley Cooke, four referees, and KimMarie McGoldrick for helpful comments, and are grateful to Jon Thor Sturluson and Gregory McKee for granting permission to use their data.

Notes

1. We have also run this experiment on six undergraduate classes over a four-year period at the University of Haifa and six sessions in a 300-student second-year microeconomics class at the University of Exeter. At Haifa, over four years it was run with 9, 9, 16, and 11 pairs in a final-year option for economics majors called “Markets, Games and Strategic Behavior and twice with three pairs in a smaller class meant for international students in a variety of majors who have all taken introductory economics (mostly Americans on their junior year abroad). At Exeter, the six sessions consisted of 10, 10, 16, 17, 10, and 10 pairs (run in that order). Results from all 12 sessions were consistent with those in Figure 3 for the ten larger sessions (when the size was 9 pairs or larger). With the two smaller size sessions (three pairs), other strategic emerged as well. These results are available with the online course materials at http://projects.exeter.ac.uk/feele/ExperimentList.shtml#HoldUpProblem.