The instability of a heterogeneous cobweb economy: a strategy experiment on expectation formation

Which strategies do agents use when forming expectations about future prices, and how often does this lead to stable or unstable outcomes? We performed a four-round strategy experiment in a cobweb economy with expectations feedback. Subjects received feedback about their performance, and could revise their strategy. Over the rounds forecasting errors decrease and realized market prices move close to the rational expectations steady state, but the complexity of the price fluctuations also increases. Convergence to the unique RE steady state occurs in less than 10 percent of all cases. In the final round, 60 percent of the price fluctuations appears to be chaotic. Heterogeneous interaction of simple prediction strategies seems to be the main source of the endogenous price fluctuations, frequently leading to a boundedly rational equilibrium of 'close to the steady state chaos'.