Economics as a Social Science: An Approach to Nonautistic Theory

6. Markets

CHAPTER 6 Markets Few people have the imagination for reality. —goethe Markets are institutions that evolved from human action in the past without initial conscious planning by anybody. As a result, there is a great deal about markets that we have tended to take for granted without being aware of what is involved. This we have learned from the attempts of the former centrally planned countries to create markets from scratch. The market is a highly useful economic instrument but idealizing it is not justi‹ed. While it is an effective instrument in helping societies generate wealth, it also favors manipulative (treating people as means) over ethical (treating people as ends) behavior. The market is not perfectly rational, its outcomes are not precisely governed by demand and supply, and, above all, it does not necessarily result in optimal outcomes or just rewards. Modern neoclassical theory presents a model of the economy that depicts it as a series of competitive markets embracing the whole economy. Everything—commodities, services, factors of production—is included. The market for any of these is standard: the demand curve slopes downward , the supply curve slopes upward, and the point where they cross sets the market-clearing (equilibrium) price at which transactions take place. It is presumed that these markets are generally competitive. Note that according to the rationality assumption all economic agents are successfully maximizing their self-interest in this process. Consequently , when the equilibrium price (the market-clearing price) is set by the intersection of the demand and supply curves, this is optimal for the economic agents concerned. This is a Pareto-optimum, but it is not optimum optimorum (the best of the best) since the unequal income distribution gives agents with the highest incomes more of what they desire while those with the lowest incomes may not be able to meet even their most vital needs. Francis Bator illustrates this point nicely: 86 In a two-person world of Adam and Eve, depending on the initial distribution of whatever, you can have an outcome where practically everything goes to Adam and nothing goes to Eve. This is still Paretoef ‹cient in the sense that you cannot recon‹gure any of the inputs or the outputs or the distribution in such a way as to make Eve better off without making Adam worse off. (Bator 1998, 202) This reservation is often overlooked, however, and the results of the market are regarded as beyond criticism, a kind of utopia or even heaven on earth. As Mancur Olson observed, it is a staple assumption that the rationality of individuals makes societies achieve their productive potential; we are already therefore in the most ef‹cient of all possible worlds (1996, 3–5). Thus, the market, in a more credulous age, could even be regarded by market -idealists as another name for God. The major, indispensable, true contribution of the market is as a means of collecting and disseminating information among its participants. This information is provided in the form of price signals or, if prices are not allowed to ›uctuate freely, by the emergence of shortages or surpluses. The market is also a coordinating mechanism. As desires, technologies, and resources change, the market provides incentives to move resources to where they are needed and divert them from uses where they are not. This view of the market as a discovery and coordinating mechanism is of course the one that Hayek stressed for years and which most economists now accept. As we have seen in chapters 3 and 4, the assumption that people always behave as rational maximizers of their own self-interest is faulty. This substantiates Hayek’s refusal to accept that the market provides a precise mathematical solution to the problem of resource allocation on the basis of exact known information or that the market necessarily leads to just outcomes. The market economy, in truth, is a ›awed, crude mechanism. Knowledge is fragmented, chaotic, and often unattainable. Participants act on the basis of their imperfect knowledge and understanding, and their in›uence on results is affected by their command of purchasing and market power. The future is uncertain and largely unpredictable. Learning by doing and technological innovation create pro‹t opportunities, knowledge is limited and often ambiguous, and externalities in production and exchange are widespread. The market, however, can be an effective tool for policy. Governments have learned that establishing a market for regulating pollution works. A maximum amount of pollution is set as a target, rights...