Category: Market Theory

Is any 'economics' being taught’

Prices- how are they formed’ Economics fundamentally is concerned with the theory of value; wherein prices play a crucial role. Does the mainstream or marginalist (neoclassical theory) explain the formation of prices’ In equilibrium, the forces of demand and supply interact to give the equilibrium prices and quantity purchased and sold. But, in reality, is it so’ Does this theory explain the actual working of any economy’

In school textbooks, I remember being taught the law of demand, factors affecting demand and the exceptions to demand. The law of demand conveniently takes into account only one factor, which is its own price. And economists like Veblen and Giffen who tried to discuss demand were sidelined as exceptions.

Thorstein Veblen talked of ‘social factors’ like status symbol, conspicuous consumption etc which affected demand. His book The Theory of the Leisure Class explains how interdependent individuals in an economy are, and how the individual is very much a part of the society unlike the ‘rationalist atomistic individual’ as assumed by the mainstream theory.

In Marshall’s Principles of Economics, he mentions Giffen effect- a rise in the price of bread results in a large drain of resources which force them to curtail the consumption of relatively expensive items like meat; and they consume more of bread as it is still the cheapest food they can get. In India, with more than 60% percent of the populace being poor [Guruswamy and Abraham], Giffen effect is the norm rather than the exception!

This post discusses some of the microeconomic concepts taught across schools and colleges.

Scarcity

I was taught that the central problems in economics were that of scarcity, of unlimited wants and how one chooses the best option. And here optimization (a mathematical apparatus) comes to the aid of economics- in finding the optimum. But are resources really scarce’ If resources were really scarce, how could an economy grow’ Land, of course is scarce; but the availability of land can be increased through reclamation, deforestation etc. Economics ought to be concerned about wants that are backed by purchasing power; otherwise the theory will be trying to reconcile dreams and scarce resources.

Equilibrium

Equilibrium is reached when the demand and supply curves intersect in the graph having quantity demanded and supplied on the x axis and price on the y axis. Joan Robinson (1973) wonders why one uses a metaphor based on space to explain a process which takes place in time.

This approach has for quite some time disturbed me. Why is it that we take ‘equilibrium’ to be favorable’ Equilibrium is a thing very commonly found in Physics. One of the meanings is that ‘it is a state of rest’ and this is precisely the meaning economists provide. For, in equilibrium, the quantity demanded will be equal to quantity supplied and all is well. Coming to think of it more, why would a stagnant economy be favorable’ What is more frightening is that, we are taught that it is what economic policies should aim at!

Prices

Prices, according to the mainstream neoclassical theory are determined based on the intersection of demand and supply; that too in a static set up. Prices, in today’s world is certainly not fixed in the before said manner. The producers decide the price based on the cost of raw materials and other items needed for production, wages and salaries of employees, advertising costs, existing taxes, etc. So this means, prices in an economy has more correspondence to the supply side than the demand side.

What is the significance of the demand side’ One of the reasons could be to point out the importance consumers have in deciding the prices in a ‘perfectly competitive’ economy. It would signify consumer sovereignty in such an economy. Again, this belief of ‘consumer sovereignty’ is something one would like to have, but is absent totally.

Perfect Competition

No student of economics graduates without studying ‘perfect competition’. It is very much entrenched in economic theory as taught today. Why’ The answer given is that it is the ideal state for an economy. Or rather, as the name suggests, it is ‘perfect’. Then we are taught about imperfect competitions keeping in mind what is good or ideal-perfect competition.

One of thoughts one could have is ‘why is it considered perfect’. The price is assumed to be given or it is said that the firm is the price taker. Another query would be- is perfect competition possible’ The main driving force behind corporations and businesses is money or precisely speaking, profits. Would firms like an atmosphere where they are unable to fix prices and hence unable to earn more profits’ It reeks of Orwell’s Animal Farm. Why would there be any competition at all’ Aren’t differences that lead to competition’ Would there be any incentive to produce or to diversify’

Conclusion

This post ends on a skeptical note. Is the current mainstream economics helping the economy by tailoring productive and progressive economic policies’ Is they are not, why are they still being taught as compulsory topics’ Is there an alternative approach’

I would like to put forth a question regarding the notion of prices.

50 years ago, one could buy a book for a rupee; but now, a book’s average cost would be about 100. This follows for all other goods and services too. What is that which accounts for this sustained rise in prices’ Is it inflation alone’

Market and the Government

The conflicting ideologies in Economics have more or less revolved around mainly two institutions- Markets and Governments. The Capitalists believe ‘Markets’ to be the panacea for all economic problems, while the Socialists replace the ‘market’ with the ‘government’.

On Markets

Market is the institutional framework within which the act of exchange takes place or the institutional milieu which is the context of the relationship of exchange between the parties. [Kurien 1993] Thus market is an institution which allows for exchange. This exchange is only possible if one of the parties have adequate purchasing power.

Markets exclude people as consumers or buyers of goods and services if they do not have any incomes, or sifficient incomes, which can be transalated into purchasing power. People experience such exclusion if they do not have assets, physical of financial, which can be used (or sold) to yield an income in the form of rent interest or profits. [Nayyar 2002]

So, relying on markets alone will exclude a large chunk of the populace of a nation. Those with relatively higher purchasing power will benefit over those will less purchasing power. And for the former, the world will become a flatter place, as Thomas L Friedman says.

On Government

A government is a body that has the authority to make and the power to enforce rules and laws within a civil, corporate, religious, academic, or other organization or group. In its broadest sense, “to govern” means to administer or supervise, whether over a state, a set group of people, or a collection of assets. [Wikipedia]

In our formal analysis of exchange and producation, the role of social norms ( Smith proposed that market exchange is sustained by the underlying social ‘norms’ resulting frm sympathy, for example, trust in exchange, respect for contracts etc.) are left out and we tend to exaggerate on one hand, the efficiency of an abstract market mechanism based on an invented ‘auctioneer’. On the other, we tend to neglect the roles which the state could play in either reinforcing or destroying these norms which are essential for the functioning of the market economy. [Bhaduri 2002]

On Globalization

Globalization is predominantly a ‘market’ centric process.

Globalization, both then and now, has been associated with an exclusion of countries and of people from its world of economic opportunities. [Nayyar 2002]

Economic globalization challenges the political authority, which the nation state had attained by undermining gradually many of the norms of the traditional civil society.[ Bhaduri 2002]

Globalization has resulted in high growth only in a selected few sectors. [Thomas 2007]

Conclusion

Relying solely on the Government to undertake the functions of the market will lead to social unrest and will result in economic inefficiency. And government regulations are a check on the markets so that a market failure does not occur.

Can markets and governments exist peacefully’ Can market and governnment produced goods and services reach an equilibrium’ Will this result in a state, where those excluded from the market will be included by the government machinery’ Is this sustainable in the long run’

References

1)Deepak Nayyar (edited), Towards Global Governance, Governing Globalization, 2002.
2)Amit Bhaduri, Nationalism and Economic Policy in the Era of Globalization, Governing Globalization, 2002.
3)C. T. Kurien, On Markets in economic Theory and Policy, 1993.

The Economics of Information-Part 1

Information in Markets

Generally, we take information to be a collection of facts from which conclusions may be drawn. If the facts tend to be accurate, then so do our conclusions. In the present market economy, information is more or less incomplete and distorted. The discipline of Economics assists us here.

First we need to define and understand what a market is, and then we need to know about the major players in the market. Market is the institutional framework within which the act of exchange takes place or the institutional milieu which is the context of the relationship of exchange between the parties. [Kurien 1993] A market is said to be efficient or in perfect competition if all the participants are fully informed about the various prices and quantities prevailing in the market. This is said to be laputan or impractical. Producers earn profits (Both normal and super normal) based on the fact that they are more informed than those buying from them. The consumers analyse and speculate, and reach conclusions based on that, thinking that they have made the best choice; where as in reality, it is not so. Most often, complaints are hurled at the firms for cheating the consumers and for being opaque in their dealings. This is known as asymmetrical information or information asymmetry.

An exchange or a transaction in a market, is a kind of zero sum game, where a gain for one participant is always at the expense of another. This is so, if we view the market as a separate entity from that of ours. In reality, the whole economy is like a spider’s web, woven closely together which makes its difficult to separately study them.

The main reasons for the exit and entry of firms is based on asymmetrical information. The feeling of ‘more information’ can attract you to the market as well as make you exit from it.

Information system is a crucial and often conveniently ignored component of a market. According to C T Kurien, the major determinants of a market are location, medium of exchange, institutional framework, intermediaries and the information system. [Kurien 1993]

The 2001 Nobel Prize for economics was awarded for the analyses of markets with asymmetric information. George A. Akerlof noted the ‘Lemon Problem’ in 1970. His popular example is that of a second hand car market, where sellers know whether or not their car is a lemon (i.e. perform badly), but where buyers cannot make that judgement without running the car. Given that buyers can’t tell the quality of the car they are buying, all cars of the same model will end up selling at the same price, regardless of whether they are lemons or not. But the risk of purchasing a lemon will lower the price buyers are prepared to pay for any car and, because second hand prices are low, people with non-lemon cars will be little inclined to put them on the market.

Asymmetric information in markets is further aggravated by the advertisements, as they portray the best in their respective products, by employing the best possible personnel. This not only distorts the true image of the product, but also places the consumer in a difficult position.

This phenomenon is present in all spheres of economic activity.

References:

1) On markets in economic theory and policy-C. T. Kurien

2) If Life Gives You Lemons ‘-Tim Harford

3) George Akerlof, Nobel Prize lecture video