On New Years Day, the Nobel Prize-winning economist Vernon Smith turned 90. To mark the occasion, Samuel Gregg wrote an essay for the Stream about Smith and the significance of his work.
Gregg explains Smith’s most famous contribution to economics:
Smith is best known for pioneering “experimental economics.” This involves behavioral experiments in which people are placed in a particular micro-economy in which they can engage in trade, but without knowing the conditions driving supply and demand. Those running the experiments can thus test the validity of particular economic theories, thereby gaining greater knowledge of how economic exchanges actually work.
Over time, experimental economics has established the importance of what Smith and others call “economic institutions,” the formal and informal rules which shape economic life in a given society. Economic institutions, it turns out, really do shape economic outcomes. From laws and regulations to customs and property arrangements, any set of rules will affect (1) the information people have and (2) the incentives that drive them.