Understanding the market

Europe and Liberty Bakuriani, July 2008

The market (or markets?)

What is economics?

« Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses »

Lionel Robbins, 1932

The classical approach of the market

Q

p demand

supplyAlfred Marshall(1842-1924)

Economic analysis of minimum wage regulation

Quantity of labor

Wage

wH

wL

w*

unemployment

Economics = Social engineering ?

1920s = Socialist calculation debate

What do we need the market (and private property) for? Centralized decision making is more efficient (Barone, Neurath, A. Lerner, O. Lange, …)

Economics system should be compared according to their use of knowledge (Hayek). Without property rights (and prices) economic calculation is impossible or extremely poor (Mises)

The knowledge problem

Knowledge is dispersed

Knowledge is partly “tacit”

Knowledge is changing

N.B. The quality of our solution to the scarcity problem depends entirely on the quality of the solution to the knowledge problem

Scarcity problem

Knowledge problem

The challenge

Finding the “system” that best deals with the knowledge problem.

We are not so much interested in allocating scarce resources with alternative uses than to increase our knowledge (in particular, knowledge about resources) and make sure that this knowledge will be used.

e.g.: leaving individuals decide for themselves boosts the use of tacit knowledge

The market

A meeting point for traders

A way to save time and money

A place for learning A place for discovery A place of wonder! A place where some

rules prevail (pieds poudrés)

Transactions to be taxed…

A spontaneous order!

Greeks’ understanding

Physei = natural order Seasons, life cycles, biological evolution,

etc. Nomos = (unnatural) order resulting

from human action Language, money, markets, Law

Thesei = (unnatural) order resulting from human design

Firms, associations, governments, contract

From the Greeks to Smith…

Tradition of the nomos Denying of the nomos

(Aquinas, B. de Sienne)Late scolastic (Molina)

Püfendorf, Grotius

Mandeville, Hume, Ferguson

Smith

Hobbes (social contract)

Bentham (utilitarianism),Rousseau (new social contract)

Descartes, Voltaire

French v. Scottish Enlightment

Descartes: One must only hold as true that which one can deduce logically from clear and distinct premises

Voltaire: “If you wish to have good laws, burn those you have and make new ones”

Ferguson: Nations stumble upon establishments, which are indeed the result of human action, but not of the execution of any human design (quoted in LLL, I, 150) = spontaneous order

Montesquieu: “Intelligent beings may have laws of their own making; but they also have some which they never made” De l’Esprit des Lois, I, p.i

From Smith to present days…

Tradition of the nomos Denying of the nomos

Say, Bastiat, M.Villey

Von Humboldt, von Savigny, Spencer

H. Maine, C. Menger

Most 20th century economists

Welfare and New welfare economics, Kelsen

Stuart and James Stuart MillAuguste Comte

Hayek, Popper, M. Polanyi, B. Leoni

Most 21st century Law and economics

Organization v. order(taxis v. kosmos)

purposeful nature degree of complexity

type of rules

spontaneous order no abstract high

general(negative)

organization yesconcret

elow commend

Market as a process

A spontaneous process of interactions framed by property rules and whose outcome at each point in time is somehow orderly and desirable.

“Paris gets fed” says Bastiat

equilibriumprices?!

Carl Menger

The “invisible hand” of Adam Smith

“by directing (his) industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention”

Essay on the Nature and Causes of the Wealth of Nations (1776)

The fingers of the invisible hand

“Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

(A. Smith)

The price system and the entrepreneur

The entrepeneur perceives a profit opportunity

Some directly benefit from its action, others loses

Some actors receive better knowledge (of what is possible and what preferences are)

There is convergence towards a unique price

Nature of profit

150 100

sell

140

buy

110

Profit = 30-costs

A closer look at the market process

It gives strong incentives to the use of tacit knowledge

It does not waste “scientific” knowledge thanks to the price system

It generates new knowledge It is unpredictable It leads to extremely complex social phenomena

Market and progress

The dynamics (progress) of societies (and economies) is due to “true” learning, that is, entrepreneurial discovery

“Nothing is more certain than that the degree of economic progress of mankind will still, in future epochs, be commensurate with the degree of progress of human knowledge.” Carl Menger, Principles of economics, 1871, page 73

Worries about market competition

It is a waste of energy (may be the oldest argument) Economic power can threaten democracy (Sherman) People will not undertake what is not profitable (public

goods) Producers will collude and block competition (cartels) or

use “unfair” strategies to win the competition Some market participants will do poorly and therefore

the market is unjust