Equilibrium is Dead, Long Live Equilibrium

The other day, I wrote: “[T]he market is always (absent externalities, interference, taxes, asymmetric information, etc) in equilibrium.  In some sense this is true*, but it is not the whole story. ”  At the time, I promised a future blog post explaining what I meant.  This is that post.

The world is always at equilibrium and always in disequilibrium.

What I mean by “the world is always at equilibrium” is twofold: 1) equilibrium analysis, as provided by the standard supply and demand chart, is a useful analytical tool.  It provides a person with a good initial understanding of exchange and production and provides reasonable predictions for things like price floors/ceilings, minimum wage, taxes, tariffs, etc etc., and 2) Any given trade, by the virtue of the fact that it is a voluntary trade, can be said to be an equilibrium trade.  That is, any trade that occurs between two individuals can be said to establish an equilibrium.

What I mean by “the world is always in disequilibrium” is that there is no “global” equilibrium, no global steady state.  Supply and demand curves are functions of endowments, and as trade occurs, endowments change.  This necessarily leads to a different set of supply and demand curves, giving new prices and new trading opportunities, leading to new trades, leading to new endowments, leading to new supply and demand curves, on and on.

The world is always in equilibrium and always in disequilibrium.

WHO is Responsible for Drug Shortages?

CNN reports in a breathless headline: The World is Running Out of Antibiotics, WHO says.  

The article is interesting as a whole.  The article begins with a description of the problem:

Too few new antibiotics are under development to combat the threat of multidrug-resistant infections, according to a new World Health Organization report published Tuesday. Adding to the concern: It is likely that the speed of increasing resistance will outpace the slow drug development process.

While the article goes on about these drug shortages, there are no questions as to why too few antibiotics are under development and why the drug development process is so slow.  A major reason for the slow development of drugs is drug regulatory agencies like the FDA!

The purpose of drug regulatory agencies is to slow down development of drugs.  The FDA (and its global counterparts) require extensive (and expensive) testing, large sample sizes, and the like, all which slow down the development process.  If these regulations were loosened, then the speed of development would increase.

However, this is not to say reducing FDA regulations are necessarily desirable.  A cost-benefit analysis would need to be done.  Are the costs of delayed drug developments, like what the WHO complains about here, worth the benefits from the FDA regulations?  It may be, in which case the slow development will have to be accepted.  However, if the costs of the delayed development are too high and exceed the benefits of the regulation, then one would need to accept a higher risk of dangerous drugs getting through in favor of quicker drug development.

In an ideal world, we would have both quick development and safe drugs; there wouldn’t need to be a trade-off between the too.  But in this less-than-ideal world we live in everything is scarce, including time.  Every second spent doing testing and meeting regulatory requirements is one second less to spend on development of new drugs (and vice versa).

On Monopolies

Earlier today, my friend Vanessa texted me the following question (small edits made for grammatical purposes):

So almost dr of economics- Am I correct in thinking monopolies are bad for consumers, thus must be bad for the economy?

Vanessa’s intuition on this question is good.  As Bastiat said, we must evaluate economics through the lens of the consumer.  Below is my response to her (sorry for the weird spacing.  I don’t know how to fix it):

“Are monopolies bad for consumers?”  This depends on what the meaning of the word “bad” means.  Monopolies are output restrictiors (that is, they get a higher price by reducing the output they make), and they produce not where price equals the marginal cost of output (ie the “zero profit” level), but the highest price they can get.  So, compared to “perfect competition,” the monopoly produces less at a higher price; they are inefficient compared to the perfect competition model.  Since “bad” is a judgment call. I’ll leave that up to you.

However, there are some situations where monopolies, as inefficient as they are compared to perfect competition, are the preferable option:
1) In economics, the only way a monopoly can naturally arise is if there are natural barriers preventing entry into the market (eg. high start-up costs, geographical barriers, that sort of thing).  We call these, shockingly enough, natural monopolies.  The implication of these conditions is that multiple forms of similar firms could not exist at the same time (ie, competition).  So, breaking up of this monopoly would not lead to lower prices and more output, but no output at all!
2) Imagine we have a firm who is a major polluter of the water.  For every item they produce, they dump a gallon of waste into the local river.  Further, assume (unlike the example in item 1 above), that this firm is not a natural monopoly.  If an effort to break up this company were undertaken, and output was to increase, then one would see an increase in the pollution dumped into the river!  From an environmental POV, this the monopoly is more efficient since it pollutes less!
Just like all economic questions, the answer is ‘as compared to what?”  It’s possible, as I explain here, that monopolies may be the preferable option.  A blanket statement like “monopolies are bad” or “monopolies are good,” depends on the context in which we’re speaking (and also what “good” and “bad” mean).

Economics as a Human Science

When discussing a new paper by GMU alum Vipin Veetil and GMU professor Richard Wagner, Scott Sumner makes the following comment:

[Veetil and Wagner] criticize the standard view, which is that in a large diversified economy the impact of micro level disturbances tend to balance out.

It is absolutely true that, at the macro level, micro level disturbances tend to balance out.  That is what’s wrong with macroeconomics.  All this aggregation masks the human element that is the core of economics.  At the end of the day, we are studying what Mises called “human action”, and what Adam Smith called “a certain propensity in human nature…the propensity to truck, barter, and exchange one thing for another.”  We are studying human behavior.  Economics is a social science; to aggregate so far as to balance out micro (ie, human) disturbances is to remove the “social” from the social science.  Our focus as economists should be on these social aspects, on these individual aspects and the institutions that arise to deal with the human element, of economics.  Anything else is, to quote James Buchanan, just applied mathematics; technically interesting, but economically useless.


Coase, Transaction Costs, and Environmental Entreprenureship

Today’s Quote of the Day comes from pages 7-8 of Ronald Coase’s 1988 book The Firm, the Market, and the Law [emphasis added]:

Markets are institutions that exist to facilitate exchange, that is, they exist in order to reduce the cost of carrying out exchange transactions.  In an economic theory that assumes transaction costs are nonexistant, markets have no function to perform and it seems perfectly reasonable to develop the theory of exchange by an elaborate analysis of individuals exchanging nuts for apples on the edge of a forest or some similar fanciful example.

Many readers of Coase (including economists!) misunderstand him.  This is evident in the improperly named Coase Theorem (it’s improper in that it’s not a theorem).  In fact, Coase is so often misunderstood, he felt compelled to write the book this quote is from to clarify his point!  Coase is often understood to say that, absent transaction costs (or sufficiently low transaction costs), externality issues (eg pollution, noise, etc) can be solved by an allocation of property rights and, regardless of their initial allocation, will result in a Pareto-efficient outcome.  This is correct, but only a partial understanding of Coase.

Much of Coase’s work (and work that spun off from him, such as with Armin Alchian, Harold Demsetz, Gordon Tullock, and many others including my own) focus on the role of the market in addressing externality issues.  Detractors from Coase argue that his insights, that markets for externalities can exist only if there are no/low transaction costs, are not applicable to the “real world,” since transaction costs abound and, therefore, government intervention is necessary.  But this argument represents a misreading of Coase.  In a purely ideal world, there would be no transaction costs, but then no market would be necessary.  As Coase says in the above quote, it is in the world of transaction costs that the market is most useful!  The existence of transaction costs gives rise to firms and other means of human collaboration, which in turn reduce transaction costs, and increase the market exchange of individuals (see The Nature of the Firm (1937) for a more in-depth conversation on this point).

Expanding the idea of markets, firms, and transaction costs to environmental issues, we see the rise of “enviropreneurs” (to use the phrasing of PERC), that is people who seek out and find ways to mitigate these transaction costs in order to achieve desired environmental ends; in short, a market process of environmental concerns (for a detailed look at many different kinds of enviropreneurs, see Free Market Environmentalism for the Next Generation, especially Chapter 9).  The fact transaction costs exist is not a detriment to free market environmentalism, like the detractors of Coase argue, but rather what allows it to come about!

Like Coase (and Buchanan and many others) before me, I realize the market is not a panacea.  There may be conditions for government to get involved (namely where involvement by the firm or an individual are too costly).  But the work of Coase (and Alchian and Demsetz and Buchanan and Tullock and Anderson and many others) show us that the mere existence of an externality and transaction costs is not enough to justify intervention.

Today’s Quote of the Day…

…is from Page 10 of Ludwig von Mises’ 1949 treatise Human Action (emphasis added):

It is true that economics is a theoretical science and as such abstains from any judgement of value.  It is not its task to tell people what ends they should aim at.  It is a science of the means to be applied for the attainment of ends chosen, not, to be sure, a science of the choosing of ends.  Ultimate decisions, the valuations and the choosing of ends, are beyond the scope of any science.  Science never tells a man how he should act; it merely shows how a man must act if he wants to attain definite ends.

Far too many economists, both in Mises’ day and today, make the very mistake Mises warns against: treating economics as a science of the choosing of ends.  They consider themselves enlightened for building models that can maximize this or minimize that, and then call for said models to influence policy.  But building models like such, as Jim Buchanan said in his 1964 paper What Should Economist Do?, is the purview not of economics, but of applied mathematics.  Indeed, anyone with even an elementary level of calculus would find such a task trivially easy.

But economics is not this; it is not merely optimizing some constrained function with some universally desired “social goal.”  Economics is the study of exchange; Of competing interests for scarce resources and the institutions that arise to deal with these issues.  In short, the study of human action.

Price Gouging Legislation Means Fewer Resources for Search & Rescue

Police, like any resource, is scarce: there simply is not enough to satisfy every want and need.

Because of this simple fact, anti-price-gouging legislation has two perverse effects on a disaster.  The first, and the one economists tend to focus on, is what I discussed the other day, namely that price controls create shortages.  The other, as the title of this post would suggest, is even more of an immediate threat to life and limb.

If police resources are diverted toward price-gouging enforcement, then that means there are fewer police resources for search and rescue operations!  A cop who has to spend his time making sure merchants don’t charge too much is not spending his time looking for people, or preventing looting, or distributing goods.

Just your daily reminder: scarcity is a thing