The strategic environment effect in beauty contest games

Recent experimental studies have shown that observed outcomes deviate significantly more from the Nash equilibrium when actions are strategic complements than when they are strategic substitutes. This " strategic environment effect " offers promising insights into the aggregate consequences of interactions among heterogeneous boundedly rational agents, but its macroeconomic implications have been questioned because the underlying experiments involve a small number of agents. We studied beauty contest games with a unique interior Nash equilibrium to determine the critical group size for triggering the strategic environment effect. We show theoretically that the effect operates for interactions among three or more agents. Our experimental results partially support this theory, showing a statistically significant strategic environment effect for groups of five or more agents. Our findings establish that experiments involving a small number of interacting agents can provide major insights into macro phenomena and bolster previous work done on such issues as price dynamics