My last post ended with no real conclusion and only one interesting result, as has been pointed out by multiple people. This post is going to rectify that, as I will begin a discussion as to when competitive markets are desired and when alternatives are actually more useful.
I'm sure some of you are already thinking something involving the idea that a market is always in the best possible condition when it is competitive. However, there are a number of reasons why competitive markets do not always maximize social utility.
The theory of capitalism is ultimately based around a simple principle - voluntary exchange. A voluntary exchange is one in which both parties agree to the exchange. This agreement is made only if both parties believe they benefit from the exchange. As all exchanges in a truly free market are voluntary, every exchange within a truly free market should, ideally, increase the utility of both parties involved.
This, of course, glosses over a trio of important points. First of all, the fact that both parties may not have equivalent knowledge about the exchange. In an instance where knowledge is not distributed equally, it is possible for a voluntary exchange to be one that is not beneficial to both parties.
Secondly, there exist a class of market failure called externalities, as described back towards my first few posts. An externality is a cost or benefit of an exchange that falls upon individuals not directly involved in the exchange.
Pollution is the class example of a negative externality, as the cost of pollution is shared by many individuals not involved in the process of creating pollution or buying the goods manufactured by said process. For positive externalities, higher education is generally used as an example, as many people benefit positively from a more educated populace but have nothing to do with the education process or the positions that are filled because of it.
Third, common property goods and public goods are not allocated properly in a free market. Public goods are non-exclusive and non-rival; that is, someone else's use of a public good does not reduce the amount of it available nor prevent someone else from using it. Common property goods are only non-rival; that is, you cannot prevent someone from using them but the use of the good reduces the amount of it that is available. Lighthouses are an excellent example of public goods, while publicly available. grazing land is the class example of a common property good.
We'll come back to some of these problems later, as my final point in this series of posts will be to determine when markets are performing optimally and how to get them to that point.
For now, let us assume that we are examining a market in which everyone has access to all information and there are no externalities. Moreover, this market is in no way related to a common property or public good.This market obviously does not exist, but these assumptions allow us to ignore some general problems and focus specifically on the competitiveness of the market.
As such, in this market any voluntary exchange will always result in a net benefit for the parties involved. This means that, generally speaking, a market holding to these conditions would provide the greatest benefit to society when the most transactions occur.
In addition, a truly competitive market would offer indistinguishable goods at the same price to all buyers, with the number of firms and buyers being to the point that no single transaction causes a change in price, no matter how large. The more competitive the market, the closer it resembles this model.
Our third and final consideration is that of economies of scale. In a market that possesses economies of scale, it is cheaper to produce goods when you produce a large number then when you produce a small number.
Now, let us examine a market for good N. Let us say that efficient production of N for a single firm falls between A and B. Let us say that there exist M different significant differentiations of good N, and that the demand for each is N1, N2, N3, ... , NM. Finally, let the total demand for N be D.
A voluntary transaction will occur if and only if both parties believe they benefit from the transaction; simply breaking even is not enough, as there is then no motivation to perform the transaction.
Let us say that there exist no significant differentiations for good N. N1 then equals D. If D < A, then either no N is produced or there is significant scarcity rent that drives up the prices for N. If A<D<B, the socially optimal number of firms producing N is one, and will be X if X*A<D<X*B.
In simple terms, the optimal number of firms in this market is the number that produce as close to the total demand for good N while staying mostly within the bounds of efficient production.
This can be extended to markets with differentiation simply by treating each differentiation of N as its own market.This is justified because each significant differentiation of N is more or less attractive to a subset of the individuals who have a desire for N and, as such, the existence of each distinct differentiation increases the possibility for voluntary exchanges.
Treating each as its own market leads us to the same conclusion as when we have no differentiation for each one, so we can simply treat a market with differentiation as a composite of markets without differentiation, with one difference - all goods within a differentiable(This analysis leaves out the idea of rent-seeking behavior, which we
will examine at a later point. This behavior sets in through the use of
monopoly power to create barriers to entry and other such cases, and
significantly changes the solutions given here.)e market provide the same service, and therefore we can substitute between them.
This means that slack from one company can be taken up by another to reduce scarcity rents and still providing opportunities for voluntary exchange.
Still, the same overall conclusion holds, even if the exact numbers are not the same. We will not go through the math here, as it is very long and does not add anything useful in addition to the short mathematical section above.
From here, we can then say that the optimal number of firms and production of firms in the market for N is almost never the same as in the model for a competitive market.
We then conclude that competitive market structures are not always socially optimal.
This is contrary to the beliefs of many people, I'm sure, but I welcome the discussion, controversy or what-have-you.
(This analysis leaves out the idea of rent-seeking behavior, which we will examine at a later point. This behavior sets in through the use of monopoly power to create barriers to entry and other such cases, and significantly changes the solutions given here.)
As I move on from here, I'll be taking time to examine other peculiarities of markets, i.e. several of the things that are assumed to not be present in this examination of competitiveness. I will, hopefully, reach a conclusion as to what can be done to move a market closer to its socially optimal form by the end of the next few posts.
Anyways. Questions, comments, suggestions, complaints, and whatnot are all welcome. Especially suggestions, so I don't run out of things to talk about. Should be able to dump them below fairly easily.
Thursday, February 23, 2012
Saturday, February 18, 2012
Non-Competitive Markets
This post is inspired by one of my friends, who asked me why it is that banks require you to pay fees and all sorts of other things, while credit unions generally do not.
Now, I'm not an expert when it comes to banks and other financial institutions. That's not what I'm interested in. However, I know the signs of a market that is not competitive when I see them. Or, at least, assuming that the above statement is correct and the services provided by a bank and a credit union are substitutes, the overall market is not competitive one.
Hence, this post is going to talk about what causes a market to become not competitive. Fairly soon I'll also have a post up talking about whether or not a non-competitive market is necessarily a bad thing, but for the moment we will leave issues of social surplus and equity in our other pants.
A market in perfect competition is the economic version of a perfect gas. That is, it doesn't exist, but it has a lot of nice properties that are theoretically important. Perfectly competitive markets have a large number of buyers and sellers, and all goods in the market are perfect substitutes for one another. No business makes a profit, and social surplus is maximized. There are a number of other minor and major theoretical details that aren't particularly important here.
What is important is to understand the criteria that define a competitive market. First, goods should be perfect substitutes. The further from perfect substitutes goods in the same market are, the less competitive the market is as a whole. The most important case in which goods are not substitutes is when product differentiation occurs, usually in the case of certain goods being better or worse. Brands and brand loyalty are also a good example of this.
The second condition is that there must be a large number of buyers and sellers. The obvious opposite case is a monopoly, a market with only one seller. There are also monopsonies, markets with only one buyer. Both show how important this particular condition is for determining if a market is competitive.
Non-competitive markets come into existence because businesses want to make a profit. In a truly competitive market, no profits are made. Again, many theoretical reasons that we will skip here, but the main important one is that, as a result of the large number of buyers and sellers and lack of product differentiation, no business can sell a good at anything more than cost without having zero customers.
Transitions from competitive to non-competitive occur, then, because businesses want to make money which, I think, is a fact we can all agree on. They go about doing this in many different ways, but they are all aimed at either positive differentiation of their own product or reducing the number of other businesses in the market.
Regardless, it can then be said that the inexorable profit seeking activity of business people is what causes a market to become less competitive, something I think some of you will find quite surprising.
Anyways. Some further examination of competition will be in order later this week. Questions, comments, suggestions, and your least favorite word in the English language can all be left in the comments section if you so wish.
Now, I'm not an expert when it comes to banks and other financial institutions. That's not what I'm interested in. However, I know the signs of a market that is not competitive when I see them. Or, at least, assuming that the above statement is correct and the services provided by a bank and a credit union are substitutes, the overall market is not competitive one.
Hence, this post is going to talk about what causes a market to become not competitive. Fairly soon I'll also have a post up talking about whether or not a non-competitive market is necessarily a bad thing, but for the moment we will leave issues of social surplus and equity in our other pants.
A market in perfect competition is the economic version of a perfect gas. That is, it doesn't exist, but it has a lot of nice properties that are theoretically important. Perfectly competitive markets have a large number of buyers and sellers, and all goods in the market are perfect substitutes for one another. No business makes a profit, and social surplus is maximized. There are a number of other minor and major theoretical details that aren't particularly important here.
What is important is to understand the criteria that define a competitive market. First, goods should be perfect substitutes. The further from perfect substitutes goods in the same market are, the less competitive the market is as a whole. The most important case in which goods are not substitutes is when product differentiation occurs, usually in the case of certain goods being better or worse. Brands and brand loyalty are also a good example of this.
The second condition is that there must be a large number of buyers and sellers. The obvious opposite case is a monopoly, a market with only one seller. There are also monopsonies, markets with only one buyer. Both show how important this particular condition is for determining if a market is competitive.
Non-competitive markets come into existence because businesses want to make a profit. In a truly competitive market, no profits are made. Again, many theoretical reasons that we will skip here, but the main important one is that, as a result of the large number of buyers and sellers and lack of product differentiation, no business can sell a good at anything more than cost without having zero customers.
Transitions from competitive to non-competitive occur, then, because businesses want to make money which, I think, is a fact we can all agree on. They go about doing this in many different ways, but they are all aimed at either positive differentiation of their own product or reducing the number of other businesses in the market.
Regardless, it can then be said that the inexorable profit seeking activity of business people is what causes a market to become less competitive, something I think some of you will find quite surprising.
Anyways. Some further examination of competition will be in order later this week. Questions, comments, suggestions, and your least favorite word in the English language can all be left in the comments section if you so wish.
Sunday, February 12, 2012
Individual Impact of Substantial Government Debt, Part Five: Conclusion
This should be my last post on this topic, so hopefully it clears up the majority of questions related to it. You can probably get through it without having read the previous four posts, but the reasoning behind the assumptions made here can be found there.
Anyways. Here goes...
Government debt effects the individual negatively in one of two ways.
The more common affect is increased inflation. This occurs as the money supply expands and confidence in the financial stability of the government drops. While inflation is not necessarily a bad thing, and is even healthy for the economy at low levels, this can become a problem when it pushes inflation upwards well in excess of economic growth.
The second affect is that of financial instability. As the government has an incredibly stable cash flow in the form of taxes, this usually has zero impact on the individual beyond the ordinary impact it has on the value of the currency. However, in cases where paying off interest becomes prohibitive to the government's functioning, reduction of services and the potential of insolvency are both issues that affect the individual in a number of major ways, which I will not elaborate here.
(If you want to examine what happens when a government declares bankruptcy, take a look at Greece.)
The ideal positive impact of government debt is that the individual stands to gain from the additional services that the government provides as a result of deficit spending.
From here, we can then attempt to answer a rather important question: when is it a good idea for the government to run a deficit?
First and foremost, the problem is one that must be examined dynamically, rather than statically. Therefore, impacts of deficit spending will be examined in the future as well as in the present.
Now, let us say that there is a service the government must run a deficit to provide. Let us further assume that the service is a net benefit to society, as, at least in my opinion, the government should be offering no services that do not have a net positive benefit to society.
If the service is one that will be provided through a number of payments over a year or even a few years, deficit spending can be the proper thing to do. It obviously depends on the magnitude of the benefit of the service provided, but there is no theoretical reason as to why deficit spending could not be a good decision in this scenario.
On the other hand, if the service is one that necessitates a certain amount of funding every year over an arbitrarily long period of time, deficit spending leads, eventually, to a debt that the government cannot handle. Even small amounts of regular deficit spending will eventually cause the interest payments on the debt to eat into the budget, requiring additional deficit spending which, in turn, yields higher interest payments. This is obviously not sustainable over the long run.
We can then say that if the service requires capital every year to continue to be provided, either the service should not be provided at all, taxes should be raised to accommodate higher necessary spending, or other services should be cut to fit the necessary budget within current tax revenues.
These two scenarios are the extreme cases, so it can be said that they may never occur. However, from them we can come to a conclusion as to when the government should decide to run a deficit, and it can be stated in a single sentence...
Governments should run a deficit only when providing a beneficial service that requires only a few infusions of capital over a short period of time.
So, yeah. Hopefully the conclusion makes some amount of sense. A lot of the reasoning is in the other posts, so I advise you read those before asking any questions.
Also, I will not pretend that the conclusion holds in all cases, as there are very few economic laws that do, let alone little ideas like this one.
Anyways. I have a few ideas for my next few posts, but if any of you can think of something in particular you'd like to see me discuss, just leave a comment and I might get around to it. Eventually. Maybe.
Anyways. Here goes...
Government debt effects the individual negatively in one of two ways.
The more common affect is increased inflation. This occurs as the money supply expands and confidence in the financial stability of the government drops. While inflation is not necessarily a bad thing, and is even healthy for the economy at low levels, this can become a problem when it pushes inflation upwards well in excess of economic growth.
The second affect is that of financial instability. As the government has an incredibly stable cash flow in the form of taxes, this usually has zero impact on the individual beyond the ordinary impact it has on the value of the currency. However, in cases where paying off interest becomes prohibitive to the government's functioning, reduction of services and the potential of insolvency are both issues that affect the individual in a number of major ways, which I will not elaborate here.
(If you want to examine what happens when a government declares bankruptcy, take a look at Greece.)
The ideal positive impact of government debt is that the individual stands to gain from the additional services that the government provides as a result of deficit spending.
From here, we can then attempt to answer a rather important question: when is it a good idea for the government to run a deficit?
First and foremost, the problem is one that must be examined dynamically, rather than statically. Therefore, impacts of deficit spending will be examined in the future as well as in the present.
Now, let us say that there is a service the government must run a deficit to provide. Let us further assume that the service is a net benefit to society, as, at least in my opinion, the government should be offering no services that do not have a net positive benefit to society.
If the service is one that will be provided through a number of payments over a year or even a few years, deficit spending can be the proper thing to do. It obviously depends on the magnitude of the benefit of the service provided, but there is no theoretical reason as to why deficit spending could not be a good decision in this scenario.
On the other hand, if the service is one that necessitates a certain amount of funding every year over an arbitrarily long period of time, deficit spending leads, eventually, to a debt that the government cannot handle. Even small amounts of regular deficit spending will eventually cause the interest payments on the debt to eat into the budget, requiring additional deficit spending which, in turn, yields higher interest payments. This is obviously not sustainable over the long run.
We can then say that if the service requires capital every year to continue to be provided, either the service should not be provided at all, taxes should be raised to accommodate higher necessary spending, or other services should be cut to fit the necessary budget within current tax revenues.
These two scenarios are the extreme cases, so it can be said that they may never occur. However, from them we can come to a conclusion as to when the government should decide to run a deficit, and it can be stated in a single sentence...
Governments should run a deficit only when providing a beneficial service that requires only a few infusions of capital over a short period of time.
So, yeah. Hopefully the conclusion makes some amount of sense. A lot of the reasoning is in the other posts, so I advise you read those before asking any questions.
Also, I will not pretend that the conclusion holds in all cases, as there are very few economic laws that do, let alone little ideas like this one.
Anyways. I have a few ideas for my next few posts, but if any of you can think of something in particular you'd like to see me discuss, just leave a comment and I might get around to it. Eventually. Maybe.
Tuesday, February 7, 2012
Individual Impact of Substantial Government Debt, Part Four: The Economy
To examine what government does to the economy, we must first examine what a large amount of debt does to a corporation.
In many cases, large amounts of debt do nothing significant, as individuals are still confident in the corporation's ability to maintain interest payments over long periods of time. On the other hand, large amounts of debt can also cause panic among investors, driving down stock prices and requiring higher interest rates to secure capital through the use of bonds.
For the government, we would ideally hope that the first case is the one that holds. Largely, it can also be shown that this is the case that holds. However, there is one major difference - deficit spending by the government causes inflation. Here's why.
Deficit spending by the government both reduces overall confidence in the government's finances and, generally, increases the supply of money available to the economy.
Considering that currency can be thought of as the government's version of 'stock,' and inflation is the devaluation of currency, a lack of confidence in government finances obviously increases inflation.
Additionally, increasing the money supply is both theoretically and empirically linked to greater inflation. The Quantity Theory of Money does a great job of explaining why this is the case, but I will leave it to you to Google it and find out more if you so wish.
As such, we can definitely say that government deficit spending will increase inflation when all other things are held constant (HAEC - holding all else constant, is an acronym I'll probably be using in the future). So, HAEC, government deficit spending will increase inflation, although the degree to which it will is not well understood.
To be clear, inflation is not necessarily a bad thing in moderation. To be even more clear, inflation equivalent to the growth rate of the economy can even be considered healthy. As such, this is a negative drawback only when inflation is increased to an unhealthy point as a result of government deficit spending.
Other effects of deficit spending on the economy are largely small and, in many cases, highly dependent on the manner of both the spending and the method of acquiring funds. For instance, the sale of additional government bonds and the general upward trend in the interest rates on those bonds over time as confidence in the government's finances decreases has an impact on the market for bonds.
However, these are all largely small impacts, and we shall ignore them as they have very little impact on the average individual.
Anyways. Apologies for not getting this up over the weekend, but I have been busier than expected. My next post will, hopefully, wrap this topic up quite nicely, but we shall see. If you have any ideas for other topics to discuss or questions or random comments, feel free to leave them.
In many cases, large amounts of debt do nothing significant, as individuals are still confident in the corporation's ability to maintain interest payments over long periods of time. On the other hand, large amounts of debt can also cause panic among investors, driving down stock prices and requiring higher interest rates to secure capital through the use of bonds.
For the government, we would ideally hope that the first case is the one that holds. Largely, it can also be shown that this is the case that holds. However, there is one major difference - deficit spending by the government causes inflation. Here's why.
Deficit spending by the government both reduces overall confidence in the government's finances and, generally, increases the supply of money available to the economy.
Considering that currency can be thought of as the government's version of 'stock,' and inflation is the devaluation of currency, a lack of confidence in government finances obviously increases inflation.
Additionally, increasing the money supply is both theoretically and empirically linked to greater inflation. The Quantity Theory of Money does a great job of explaining why this is the case, but I will leave it to you to Google it and find out more if you so wish.
As such, we can definitely say that government deficit spending will increase inflation when all other things are held constant (HAEC - holding all else constant, is an acronym I'll probably be using in the future). So, HAEC, government deficit spending will increase inflation, although the degree to which it will is not well understood.
To be clear, inflation is not necessarily a bad thing in moderation. To be even more clear, inflation equivalent to the growth rate of the economy can even be considered healthy. As such, this is a negative drawback only when inflation is increased to an unhealthy point as a result of government deficit spending.
Other effects of deficit spending on the economy are largely small and, in many cases, highly dependent on the manner of both the spending and the method of acquiring funds. For instance, the sale of additional government bonds and the general upward trend in the interest rates on those bonds over time as confidence in the government's finances decreases has an impact on the market for bonds.
However, these are all largely small impacts, and we shall ignore them as they have very little impact on the average individual.
Anyways. Apologies for not getting this up over the weekend, but I have been busier than expected. My next post will, hopefully, wrap this topic up quite nicely, but we shall see. If you have any ideas for other topics to discuss or questions or random comments, feel free to leave them.
Thursday, February 2, 2012
Short Post and Apologies
Considering that my last post ended with me stating that my regular update times would be Tuesday, Thursday, and some time on the weekend, it feels rather bad to fail on the very first day...
Regardless, I'm not going to be posting anything long today, as I am quite busy. However, I do have a picture that, I believe, will yield some interesting thoughts. It also relates to the topic I am currently on, which is always a plus.
So, here's a picture, I hope you enjoy it, I'll be posting again tomorrow or the next day to make it up to you.
Regardless, I'm not going to be posting anything long today, as I am quite busy. However, I do have a picture that, I believe, will yield some interesting thoughts. It also relates to the topic I am currently on, which is always a plus.
So, here's a picture, I hope you enjoy it, I'll be posting again tomorrow or the next day to make it up to you.
Subscribe to:
Posts (Atom)