Misperceptions of feedback in dynamic decision making

In recent years laboratory experiments have shed significant light on the behavior of economic agents in a variety of microeconomic and decision-theoretic contexts such as auction markets, portfolio choice, and preference elicitation. Despite the success of experimental techniques in the micro domain, there has been relatively little work linking the behavior of decision makers to the dynamics of larger organizations such as corporations, industries, or the macroeconomy. This paper presents a laboratory experiment in which subjects manage a simulated economy. Subjects must invest sufficient capital plant and equipment to satisfy demand. Subjects were given complete and perfect information regarding the structure of the simulated economy, the values of all variables, and the past history of the system. Nevertheless, the overwhelming majority of the subjects generate significant and costly oscillations. A simple decision rule based on the anchoring and adjustment heuristic is shown to simulate the subjects' decisions quite well. Several distinct sources of the subjects' poor performance are identified and termed “misperceptions of feedback.” The decision rule is related to various models of economic fluctuations; implications for experimental investigation of dynamic decision making in aggregate systems are explored.