CHAPTER 3 THE FRICTIONLESS PLANE FALLACY Why more competition is not always betterRead more at location 1024
Kelvin Lancaster and Richard Lipsey published a paper in the Review of Economic Studies with the unassuming title “The General Theory of Second Best”—and handed the left one of the most powerful arguments against laissez-faire capitalism ever developed. Never heard of it? Well, don’t feel bad—you’re not alone. It’s been “suppressed” by the economics profession.Read more at location 1026
One of the most ideologically powerful theoretical results in modern economics is the so-called Invisible Hand Theorem—named after Adam Smith’s famous speculation—thatRead more at location 1039
What the Second Best Theorem shows is that even if this is true, it is irrelevant, because if even one of the conditions that are required for perfect efficiency is violated, anywhere in the economy, then all bets are off. There is no reason to think that a “second-best,” or almost perfectly competitive market, will be more efficient than a third-best, or fourth-best, or even totally uncompetitive market.Read more at location 1041
the authors went on to show that, in cases where one of the conditions required for perfect efficiency was violated, the only way to achieve as-close-as-possible-to-perfect efficiency would be to go out and violate a few more of the rules required for a perfectly competitive market.Read more at location 1046
Using a jigsaw is a very inefficient way to cut down a tree, compared to using a chainsaw. But what about the outcome, cutting down the tree? It may be more or less desirable, but it cannot be efficient or inefficient, unless there is some other purpose that it is intended to serve,Read more at location 1053
According to this sense of the term, an outcome in which it is impossible to improve one person’s level of satisfaction without decreasing someone else’s is called “efficient”Read more at location 1056
The prisoner’s dilemma sketched out in the first chapter contains, in this respect, a paradigm instance of an inefficient outcome.Read more at location 1061
The “state of nature,” in this respect, is a condition of total inefficiency, caused by a complete failure of cooperation.Read more at location 1065
Suppose you are distributing candy to kids at a birthday party. Being inexperienced at this sort of thing, you do it all wrong: You divide it up evenly among them, forgetting that some of them are allergic to peanuts, some of them hate raisins, and some of them have weird food sensitivities you’ve never even heard of.Read more at location 1067
Of course, figuring out exactly who should get what would be a very complicated job. You might decide instead just to let the kids take care of it by themselves.Read more at location 1073
“Markets will clear,” as economists like to say. When there are no more beneficial trades that can occur, the outcome will be perfectly efficient.Read more at location 1076
This little thumbnail sketch is pretty close to being a complete statement of the intuition underlying the Invisible Hand TheoremRead more at location 1079
In order to get the ideal distribution of candy, perfectly adapted to everyone’s preferences, there is no need for any complicated exercise in planning.Read more at location 1081
Furthermore, the people involved don’t need to be motivated by any concern for the common good.Read more at location 1083
Suppose you are the manager of a supermarket, and you are trying to figure out a way to get as many customers through the checkouts in the shortest time possible. You don’t want some cashiers standing around idle while others have huge lineups. How to solve the problem? Do you need some sort of high-tech system to constantly scan the crowds, combined with an optimal queuing algorithm to assign waiting customers to lineups? Instead, why not just let the customers look for themselves and choose their own lines?Read more at location 1089
No one doubts that one voluntary exchange leads to an improvement in efficiency. But the Invisible Hand Theorem claims that when every economic transaction is organized as a voluntary exchange, then all of the available improvements in efficiency will be exhausted.Read more at location 1107
there was an enormous gap between whatever platitudinous intuitions we may have about the benefits of exchange and the defense of a completely laissez-faire economy. This may help to explain why it took economists such a long time to come up with anything resembling a proof of Smith’s conjecture. Indeed, it was not until 1956 that Kenneth Arrow and Gerard Debreu’s “general equilibrium” model showed how such a proof could be constructed.Read more at location 1118
Arrow and Debreu had to adopt a rather dramatic series of idealizations. (For example, they assumed that everyone had perfect information about the goods they were about to purchase, that goods never had to be transported from one location to another, that everyone knew the prices that everyone was charging for everything, now and for the foreseeable future, and so on.)Read more at location 1123
A debate immediately broke out among economists (and other interested parties) about whether the approximation was close enough to justify drawing any sort of “real world” conclusionsRead more at location 1129
Everyone assumed that if the assumptions of the model mapped onto the real world in some approximate way, then the results of the model could also be mapped back in much the same way. This was the error diagnosed by Lipsey and Lancaster.Read more at location 1131
the extent to which the model approximates the real world with respect to competition says nothing at all about the extent to which it maps onto the world with respect to efficiency.Read more at location 1132
Suppose you live somewhere in the Midwestern United States, and your dream vacation is to go to Hawaii for a week. You could also go to Las Vegas, but that would be about half as much fun. Unfortunately, you don’t have quite enough money to pay for a flight to Hawaii. On the other hand, you could drive to Las Vegas, which would cost much less. Now suppose a travel agent offers you the following deal: “You can’t afford to fly all the way to Hawaii, but I’m willing to sell you a ticket at a reduced fare that will get you 98% of the way. Granted, it doesn’t quite get you to your dream vacation. But isn’t getting 98% of your dream vacation better than settling for Las Vegas, which is worth only 50% as much?” This is obviously a crazy suggestion. Getting 98% of the way to Hawaii puts you somewhere in the Pacific Ocean.Read more at location 1135
Note: IMO: MAL COMPRESO IL TEOREMA DELLA MANO INVISIBILE. LE H. SODDISFANO 100 E LAS VEGAS 50. MA DOVE SONO I BENI (O I PACCHETTI DI BENI) DI 51 52 53… 98 99? EVIDENTEMENETE MANCANO I LORO MERCATI. MA IL TEOREMA DICE PROPRI QUELLO: DOVE C È INEFFICIENZA È XCHÈ MANCA UN MERCATO!!!!! Edit
The fallacy lies in thinking that getting something that is the closest approximation to the best is necessarily better than getting something rather different.Read more at location 1143
(if the salad dressing you want isn’t available, maybe you’d be better off ordering the soup; if you don’t get the raise you want, maybe you should be working somewhere else).Read more at location 1144
Anyone can see that the idealizations introduced by Arrow and Debreu in their characterization of perfect competition are fairly extreme. In order for their theoretical results to have any direct bearing on the real world, there must be no economies of scale (which means no advantages to mass production), no possibility of influencing prices through one’s supply or demand decisions, no transaction costs (a category that includes everything from lawyer’s fees and accounting expenses to transportation costs and unpaid bills), no uncertainty about the future (or, in situations where there is uncertainty, an option to purchase insurance against any eventuality), and no information asymmetries (in particular, customers who know everything that the manufacturer knows about the products they are considering purchasing). And most important of all, there must be no “externalities,” which is to say, no uncompensated costs or benefits imposed upon others.8 What this means, in practice, is that there would have to be a “complete” set of property rights:Read more at location 1152
The neighbor can produce foul odors, make loud noises, or install hideous lawn ornaments without infringing upon our property rights, because we have no property rights in the air that we breathe, in our acoustic environment, or in the view out the front window.Read more at location 1168
This is the world of perfect capitalism. As anyone can see, it doesn’t bear much resemblance to the real world. Not a problem, say the defenders of laissez-faire—there’s nothing wrong with using idealizations in the development of scientific theories.Read more at location 1178
It’s not just that the ideal Newtonian model is “close enough” to the real world to generate useful predictions. It’s that the more closely the real world resembles the ideal world of Newtonian mechanics, the more closely our observations will satisfy the predictions of the ideal model.Read more at location 1192
The point of developing models—simplified representations of some aspect of the real world—is to disaggregate things, so that instead of talking about everything all the time, one can isolate and discuss just some of the forces that are contributing to a particular observed phenomenon. This is often referred to as the “frictionless plane”Read more at location 1198
Galileo ignored friction entirely, which meant that his model did not directly correspond to any actual experimental observations. Nevertheless, it provided an analysis that was close enough for all practical purposes,Read more at location 1202
Thus there is nothing wrong in principle with using idealizations like the “frictionless plane”Read more at location 1204
Milton Friedman (father of the infamous “Chicago School”) appealed to the analogy of geometry in defending the assumption that everyone faces a fixed (or exogenously determined) set of prices under perfect competition: Of course, competition is an ideal type, like a Euclidean line or point. No one has ever seen a Euclidean line—which has zero width and depth—yet we all find it useful to regard many a Euclidean volume—such as a surveyor’s string—as a Euclidean line. Similarly, there is no such thing as “pure” competition. Every producer has some effect, however tiny, on the price of the product he purchases. The important issue for understanding and for policy is whether this effect is significant or can properly be neglected, as the surveyor can neglect the thickness of what he calls the “line.”Read more at location 1205
