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So it seems I need to talk about this, and my space is probably more appropriate than cluttering up somebody else's any more than I already have.
When you go to college and start studying something, no matter what it is, the first few classes you take tell you lies. They're not doing it to mislead you, they're doing it because you don't have the background and training to understand the advanced concepts yet.
In physics, when you start to talk about light, they get out the big rubber band to teach you about wavelength and frequency, resonance and the Tacoma Narrows Bridge. "Light is like this", they say, even though light is almost *nothing* like that.
In geology, they tell you about C14 dating, point out that C14 findings are consistent with other methods of dating artifacts--such as deposit layers, and leave it at that. They don't have time to explain the drawbacks of C14 dating, or that where C14 dating falls down, they have other, well-tested methods.
In economics, they whip out the supply and demand model of a market, wave their Invisible Hand* at you, and talk about what happens when you vary elasticity, taxation, cost curves, and the like. They don't itemize their assumptions, because they distract from your understanding of the basic concepts.
So here, for your edification, is an incomplete list of the assumptions they *don't* tell you about in your early Econ classes that are required for the market to work the way they say it works:
1) Perfect information. This means that everybody involved in the market knows everything there is to know about the market. Nobody is holding back information. All costs, benefits, and risks are not only known to all parties, but are also correct.
2) Perfect competition. There are a very large number of competing entities, both on the supply side and on the demand side, all of whom can participate or not participate as they see fit based entirely on price.
3) No barriers to entry or exit. It does not cost anything to start a business in this market, and it does not cost anything to close down a business in this market. No capital expenditures, no development costs, just start selling your good or service. Get tired of it? Just stop.
4) An increasing marginal cost curve. At some point, it starts costing you more to produce the next unit than it cost you to produce the last one. Oil is a good example here, as each barrel of oil has to be pumped from a *little* bit deeper than the last one, and each new oil field is a bit harder to get to. At some point, a company won't be able to afford to get any bigger, because their next unit of product will cost them so much that nobody will buy it at a price that makes it worth producing it in the first place.
5) No externalities. An externality is any effect of a transaction whose cost or benefit is not accounted for in the price of the good or service in question. This is a tough concept for a lot of even advanced Econ students, though I'm not exactly sure why. Take pollution, for example--because nobody "owns" the air, any damage to the atmosphere done by your factory releasing smoke into the air does not result in a cost on your balance sheet, and that cost is thus not passed on to the consumer. (This concept is what is behind "cap-and-trade" legislation--it's an attempt to formalize the damage that's being done to the atmosphere, and make those responsible for that damage pay for the cleanup, or at least make them consider the effects of their actions, and pass the costs along to the consumer, in the hopes that if it's more expensive to buy stuff that pollutes, maybe people will switch to greener alternatives.) And while pollution is the classic example, there are literally thousands of other externalities present in the overall economy.
As I say, an incomplete list of assumptions. And why, you may ask, did I select this particular list? It's because none of these assumptions are true in the real world.
OK, there certainly are plenty of markets that do have a rising marginal cost curve--I even listed an example. But there are a surprising number of markets that do not face this constraint--software is an almost perfect counterexample--once you've spent your millions developing Windows, it costs almost nothing to stamp one more DVD and ship it to Best Buy. Other classic "natural monopolies" include telephony, cable or satellite TV, electricity, clean water, Internet access, and apparently Wal*Mart.
And while something approaching perfect competition *has* been observed in the wild, go ask a family farmer how that worked out for him. Assuming you can still find one--what happened there is competition forced farmers to lower their prices *below* their marginal cost, which works for a little while because there's some slack in there from all the earlier units produced which *didn't* cost quite as much to produce, but in the long run, or after one poor harvest, all the debt came due, many farmers couldn't keep up the payments, foreclosures happened, and big agribusiness stepped in, bought up all the little farms from the bank, and then went about driving the rest of the small farms out of business.
Without these assumptions, the market does not operate to the benefit of society. Instead, it operates to the benefit of whoever can take advantage of inefficiencies the best--the monopolists, or the colluding oligarchs, or the fraudulent.
We need regulation of markets, to punish those who defraud, to rein in those who abuse monopolies, and to bring the costs of externalities back into play.
Capitalism is a tool, like a hammer. You use it for what it's useful for, and for what it can't do, you use a different tool. Maybe I'll discuss that other tool sometime soon, though I warn you--that tool, when unrestrained, sucks just as bad--maybe more--as unfettered capitalism does.
*Do you see what I did there?
Note to folks coming over from Facebook (or elsewhere): Anonymous comments are welcome here if you don't have or want an LJ account, but please do me the favor of identifying yourself in your comment. Thanks!
When you go to college and start studying something, no matter what it is, the first few classes you take tell you lies. They're not doing it to mislead you, they're doing it because you don't have the background and training to understand the advanced concepts yet.
In physics, when you start to talk about light, they get out the big rubber band to teach you about wavelength and frequency, resonance and the Tacoma Narrows Bridge. "Light is like this", they say, even though light is almost *nothing* like that.
In geology, they tell you about C14 dating, point out that C14 findings are consistent with other methods of dating artifacts--such as deposit layers, and leave it at that. They don't have time to explain the drawbacks of C14 dating, or that where C14 dating falls down, they have other, well-tested methods.
In economics, they whip out the supply and demand model of a market, wave their Invisible Hand* at you, and talk about what happens when you vary elasticity, taxation, cost curves, and the like. They don't itemize their assumptions, because they distract from your understanding of the basic concepts.
So here, for your edification, is an incomplete list of the assumptions they *don't* tell you about in your early Econ classes that are required for the market to work the way they say it works:
1) Perfect information. This means that everybody involved in the market knows everything there is to know about the market. Nobody is holding back information. All costs, benefits, and risks are not only known to all parties, but are also correct.
2) Perfect competition. There are a very large number of competing entities, both on the supply side and on the demand side, all of whom can participate or not participate as they see fit based entirely on price.
3) No barriers to entry or exit. It does not cost anything to start a business in this market, and it does not cost anything to close down a business in this market. No capital expenditures, no development costs, just start selling your good or service. Get tired of it? Just stop.
4) An increasing marginal cost curve. At some point, it starts costing you more to produce the next unit than it cost you to produce the last one. Oil is a good example here, as each barrel of oil has to be pumped from a *little* bit deeper than the last one, and each new oil field is a bit harder to get to. At some point, a company won't be able to afford to get any bigger, because their next unit of product will cost them so much that nobody will buy it at a price that makes it worth producing it in the first place.
5) No externalities. An externality is any effect of a transaction whose cost or benefit is not accounted for in the price of the good or service in question. This is a tough concept for a lot of even advanced Econ students, though I'm not exactly sure why. Take pollution, for example--because nobody "owns" the air, any damage to the atmosphere done by your factory releasing smoke into the air does not result in a cost on your balance sheet, and that cost is thus not passed on to the consumer. (This concept is what is behind "cap-and-trade" legislation--it's an attempt to formalize the damage that's being done to the atmosphere, and make those responsible for that damage pay for the cleanup, or at least make them consider the effects of their actions, and pass the costs along to the consumer, in the hopes that if it's more expensive to buy stuff that pollutes, maybe people will switch to greener alternatives.) And while pollution is the classic example, there are literally thousands of other externalities present in the overall economy.
As I say, an incomplete list of assumptions. And why, you may ask, did I select this particular list? It's because none of these assumptions are true in the real world.
OK, there certainly are plenty of markets that do have a rising marginal cost curve--I even listed an example. But there are a surprising number of markets that do not face this constraint--software is an almost perfect counterexample--once you've spent your millions developing Windows, it costs almost nothing to stamp one more DVD and ship it to Best Buy. Other classic "natural monopolies" include telephony, cable or satellite TV, electricity, clean water, Internet access, and apparently Wal*Mart.
And while something approaching perfect competition *has* been observed in the wild, go ask a family farmer how that worked out for him. Assuming you can still find one--what happened there is competition forced farmers to lower their prices *below* their marginal cost, which works for a little while because there's some slack in there from all the earlier units produced which *didn't* cost quite as much to produce, but in the long run, or after one poor harvest, all the debt came due, many farmers couldn't keep up the payments, foreclosures happened, and big agribusiness stepped in, bought up all the little farms from the bank, and then went about driving the rest of the small farms out of business.
Without these assumptions, the market does not operate to the benefit of society. Instead, it operates to the benefit of whoever can take advantage of inefficiencies the best--the monopolists, or the colluding oligarchs, or the fraudulent.
We need regulation of markets, to punish those who defraud, to rein in those who abuse monopolies, and to bring the costs of externalities back into play.
Capitalism is a tool, like a hammer. You use it for what it's useful for, and for what it can't do, you use a different tool. Maybe I'll discuss that other tool sometime soon, though I warn you--that tool, when unrestrained, sucks just as bad--maybe more--as unfettered capitalism does.
*Do you see what I did there?
Note to folks coming over from Facebook (or elsewhere): Anonymous comments are welcome here if you don't have or want an LJ account, but please do me the favor of identifying yourself in your comment. Thanks!
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From:
no subject
I do not oppose free markets, but as you eloquently point out they do not obtain in nature. I would add that it is in the rational self interest of 'whoever can take advantage of inefficiencies the best' to perpetuate these departures from the ideal. Self interest being the name of the game they can not be faulted, but the role of regulation is (or should be) to limit (or correct) these distortions. I am frustrated by a number of variations on this theme: drilling in ANWR will affect the global price of oil, or, the cost of a large uninsured population is not already somehow being paid. Particularly galling to me are politicians who raise the battle cry against socialism while heavily subsidizing, say, corn production.
Deviations from ideal conditions aside, a free market does not give a flying fig as to who gets what. The market mechanism may bake the biggest pie, but it is not concerned with the size of the slices. You end pointing out that capitalism is a tool. But a tool, to be useful, requires a task.
From:
no subject
Yup. I'll be addressing communism soon. Stay tuned!
From:
i'd like to build a staircase
From:
Re: i'd like to build a staircase
All you can do is define the rules for how those transactions take place. Without some set of rules, theft and extortion are the transactions of choice. And then, once you do choose a ruleset, it turns out that different rules incentivize different behaviors.
Oh, and cheating always happens.
From:
Re: i'd like to build a staircase
From:
Re: i'd like to build a staircase
From: (Anonymous)
Re: i'd like to build a staircase
In any case, as such they were off topic. My frustration (which we seem to share) with the glib treatment the assumptions made economists receive feeds into my frustration that reform and regulation never does try to achieve the ideal result that makes market economics, at least on paper, so attractive. This in turn adds to, or perhaps more accurately is a facet of, my broader frustration that as a species with no natural constraint but our resources and ourselves but with the capacity to envision and pursue complex outcomes, have no 'game plan'. Which I mean in a very loose sense. These frustrations, stronger yet than my frustration with the Philadelphia Phillies at the moment (if you can believe that... bleeping Yankees) got the better of me. So I apologize.
Thanks again for the post though. It was cathartic.
From:
Re: i'd like to build a staircase
From:
Re: i'd like to build a staircase
I think I agree more with your comments about not having a game plan than with "rulesets require outcomes they are designed to (attempt) achieve"--I think that the vast majority of economic and political rules and law are designed--to the extent that they are designed at all--not to achieve a desired outcome, but to prevent an outcome that appears to some subset of society to be undesirable. It is a vitally important distinction--the methodology is reactive rather than proactive, and the resulting "system" is cobbled-together rather than planned, fundamentally broken rather than basically functional.
Had "rulesets require" been, rather, "rulesets should require", I think we would be in vehement agreement.
You can't blame the Phillies. MLB is broken as a competitive sport, and the Yankees have been the primary factor in breaking it.