Class 4 Problems with markets Transactions costs bargaining and the PPF Where we are going Markets can promote good outcomes but we often don t use them Transactions costs the cost of making market exchanges contracts negotiating and policing the exchange of property rights Good social institutions lower transactions costs facilitating division of labor through markets Markets discourage caring work Markets miss the benefits of complementary production where PPF is upward sloping Do we have the right institutions to link desire to supply Central question in evaluating whether capitalism is a good system Do markets lead producers to make the stuff that people want and not make the stuff that people value less than the real cost The Amherst farmers market works well Because people are honest there 1 14 19 06 42 AM If markets are so great Why do we have families Why friends Why do we give medals instead of cash bonuses Why don t we sell grades We have nonmarket systems because Markets can be expensive transactions costs Markets can promote bad behaviour to take advantage of inadequate policing If markets are so great why don t we use them more Relatively little economic activity is through markets More is by command in families businesses governments Institutions that don t rely on self interest and need policing Did you pay your parents for dinner 1 Of course And they make sure to cook what I want so that I ll come back 2 Never 3 No but I did the dishes for free And I laughed at my dad s old jokes We shun markets because of Transactions Costs Costs of conducting exchanges and protecting property This includes the cost of waiting on line to pay Bank forms Policing transactions is expensive 3 million cashiers 1 5 million bookkeepers a million lawyers and a million security guards Unproductive they protect markets Not all work hard 1 14 19 09 29 AM06 42 AM Good Social Policy Can Lower Transactions Costs Encourage honesty Promote literacy Establish good infrastructure honest judiciary and police legitimacy through justice 1 14 19 09 29 AM06 42 AM Selfishness leads to bad behavior How much to spend guarding 1 14 19 09 29 AM06 42 AM Honest communities manage with fewer security guards and accountants Transactions costs lower productivity In an honest society fewer workers are wasted policing transactions Businesses can concentrate on becoming efficient and producing desirable products Why don t we become honest Transactions costs makes puppy sad They should make you sad because they raise the cost of everything we buy or sell As much as a quarter of the American labor force guards stuff This includes supervisors guards prisoners and the military They protect property rights and enforce contracts They produce nothing 1 14 19 06 42 AM Problem 2 Markets discourage non market work They discourage community work volunteer work and care for those who can t buy care If we rely on markets Who will care for children the disabled the elderly the environment 1 14 19 09 29 AM06 42 AM And who will care for the kittens 1 14 19 09 29 AM06 42 AM Orthodox economists assume markets perfectly match desires to production Orthodox neoclassical theory has 3 elements Preferences Factor endowments Technology By discounting institutions neoclassical economists explain everything with 3 things Assumes no transactions costs Preferences Demand Technology factor endowments Supply Neoclassical story ends with supply and demand No place for institutions politics history or conflict 1 14 19 09 29 AM06 42 AM Transactions costs change everything Creates gap between price of supply and demand There are things we want that don t happen because of transactions problems Size of gap depends on social conditions honesty and institutions Bargaining and threats matter 1 14 19 09 29 AM06 42 AM Problems with markets III Upward sloping Production Possibilities Frontier Production possibility frontier maximum output given physical constraints You could grow poppies or roses More poppies fewer roses More roses fewer poppies More roses less heroin land is used for poppies 06 42 13 AM Production Possibility Frontier Afghan Farmers Poppies Unattainable Too little land Inefficient RosesYou can 06 42 13 AM have more Moving along the line you get more poppies by shifting resources away from producing roses The price of poppies is the roses you don t produce The opportunity cost of roses is the poppies you don t produce and vice versa 06 42 13 AM Consider the sex sleep dilemma and the Production Possibility Frontier PPF neoclassical idea technology factor endowment determine supply 1 14 19 09 29 AM06 42 AM Crucial assumptions slip in here Sex and sleep are substitutes not complements People are always on the efficient frontier Both assumptions are wrong 1 14 19 09 29 AM06 42 AM First Production Possibility Frontiers for substitutes and complements Substitutes Producing one does not help you produce the other but it takes resources away Examples Limited land to produce rye or wheat rye Use the land for rye or use it for wheat Growing one does not help you grow the other wheat 1 14 19 09 29 AM06 42 AM Production Possibility Frontiers with more efficiency You are more productive and the PPF goes out More productive in both rye wheat 1 14 19 09 29 AM06 42 AM Production Possibility Frontiers with more efficiency Maybe you have weather that is good for wheat but not rye PPF goes out for only wheat More productive in Wheat rye wheat 1 14 19 09 29 AM06 42 AM Production Possibility Frontiers with less efficiency Bad weather and you are less productive in both The PPF comes in Less productive in both rye wheat PPF for complements where one helps you do the other The bees that fertilize your apple grove also make honey More apples and more honey More apples more bees more honey Curve is positively sloped for production complements The curve may bend back because there may be a limit to production with some fixed inputs honey Apples Sex and sleep can be complements Communication can make both better Do you want me to go into detail There are books about this No not those Cooperating and communicating we can sleep better and have better sex Sleep rest Good communicating Mostly fighting Sexual pleasure Are we always on the frontier Or do transactions problems get in the way Do you always have the amount of sex and sleep that you want How much time to you waste arguing about it How often do you not even try to get what you want in a relationship