Home > Economics in Two Lessons > Competitive equilibrium (excerpt from Economics in Two Lessons)

Competitive equilibrium (excerpt from Economics in Two Lessons)

July 18th, 2015

I’m now coming up to (what I hope will be) the most challenging part of my book-in-progress, Economics in Two Lessons. The core theoretical point the first part of the book (Lesson 1) is that, under a set of ideal assumptions, competitive equilibrium prices both reflect and determine the opportunity costs faced by consumers and produces. This means that there is no way to rearrange consumption to make someone better off unless someone else is made worse off. (I’ve already mentioned my reasons for avoiding the term “Pareto-optimal” in this context.

What I’m trying to do here is to spell out the logic underlying these results in a way that foreshadows the discussion of market failure and income distribution, in Lesson 2, but still shows the power of market mechanisms. I’ll probably need a few goes at this, and this is my first try. Critical comments on everything from the underlying theory to editorial nitpicks are welcome. Sincere praise is also welcome of course, but constructive criticism is best of all.

Competitive equilibrium

Let’s restate Lesson 1:

Market prices reflect and determine the opportunity costs faced by consumers and producers.

We’ve seen how market prices determine the opportunity costs we face in making economic decisions as consumers, workers and producers of goods and services. We can’t as individuals, change the market prices we face for goods and services in general, so we must take them as given in looking at the opportunity cost of different choices.

But Lesson 1 says something more, namely that market prices also reflect opportunity costs. That is, just as the opportunity costs of our choices are determined by market prices, those market prices are determined by our choices. Under ideal conditions, those choices, aggregated over all the members of a society, will reflect the opportunity costs for that society as a whole.

There is a large branch of economic theory devoted to proving results of this kind using formal mathematics. But the core of the idea may be approached using the idea of ‘no free lunches’ or, more precisely, ‘no benefits without equal opportunity costs’, discussed in the previous section.

As we saw then, this condition requires that all production be technologically efficient. If not, there is always a free lunch to be had by making production more efficient, producing more with the same inputs.

The second requirement ‘no free lunch’ requirement is that there should be no gains from mutually beneficial exchange remaining to be realised. It’s easy to see that this requirement is closely related to market prices.

Example 2: lets suppose that you own a new jacket that you would be willing to trade for tickets to tonight’s baseball game, while I have tickets and would be willing to trade them for your jacket.

Now lets look at market prices. If the market price of the jacket is greater than the price of the tickets, there is no need for you to trade with me. You can (assumption A) sell the jacket at the market price (which is unaffected by assumption C), use the proceeds to buy the tickets and have money left over. Since you make the best possible choices (assumption D) that’s what you will do. If I want to complete the trade, by selling my tickets and buying the jacket, I will have to make up the price difference. By assumption (E), no one else is affected.

On the other hand, if the market price of the jacket is less than that of the tickets, the fact that this price prevails indicates that there must be someone else willing to sell jackets, and buy tickets at those prices. So, I can sell my tickets and use the proceeds to buy a jacket, making an exchange that benefits both me and the other parties involved. You, on the other hand, am out of luck. At the prevailing prices, no one is willing to trade tickets for a jacket, and there are no remaining exchanges to be made.

This simple examples give a flavor of the argument that leads to Lesson 1. Intuitively, it suggests the conclusion that trade at market prices will capture all the potential gains from mutually beneficial exchanges, so that no free lunches will be left on the table. In other words, in market equilibrium, TANSTAAFL holds.

This is where casual presentations of Lesson 1 commonly stop. But the simple story above embodies a lot of assumptions about the way markets work:

The most important are:

(A) Everyone faces the same market-determined prices herefor all goods and services, including labor of any given quality, and everyone can buy or sell as much as they want to at the prevailing prices

(B) Everyone is fully aware of the prices they face for all goods and services, including how relevant uncertain events might affect those prices

(C) No one can influence the prices they face

(D) Everyone makes the best possible choices given their preferences and the technology available to them

(E) Sellers bear the full opportunity cost of producing the good, and buyers receive the full benefit of consuming it, no more and no less. That is, no one can shift costs associated with production or consumption to anyone else without compensation (for example, by dumping waste products into the environment) and no one else receives benefits for which they do not pay.

We can go back to the example to see where each of these conditions fits in

If the market price of the jacket is greater than the price of the tickets, there is no need for you to trade with me. You can (assumption A) sell the jacket at the market price (which is unaffected by assumption C), use the proceeds to buy the tickets and have money left over. Since you make the best possible choices (assumption D) that’s what you will do. If I want to complete the trade, by selling my tickets and buying the jacket, I will have to make up the price difference. By assumption (E), no one else is affected.

This more complicated version of the story can be formulated in mathematical terms to show that, under the stated conditions (and some additional technical requirements), a competitive equilibrium will arise in which there are no free lunches; that is, any potential benefit entails an opportunity cost that is at least as great.

In this ‘perfectly competitive equilibrium, the price of any particular good good is equal, for everyone who consumes that good, to the opportunity cost of a change in consumption, expressed in terms of the alternative possible expenditures. Similarly, firms can maximise profits only if the prices of the goods they produce are equal to the opportunity cost of the resources that could be saved by producing less of those goods.

This point is the core of Lesson 1. In a perfect competitive equilibrium prices exactly match opportunity cost. So, there are no ‘free lunches’ left. More precisely, any additional benefit that can be generated for anyone in the economy must be matched by an equal or greater opportunity cost, where opportunity cost is measured by the goods and services foregone, valued at the equilibrium prices. This opportunity cost may be borne by those who benefit from the change or by others.

Hazlitt, and many subsequent writers, implicitly assume something much stronger: that if prices reflect opportunity costs, there is no room for improvement in public policy. In particular, he assumes that any policy that benefits one group at the expense of others is undesirable. To put it more strongly, the distribution of income associated with competitive market equilibrium, based on existing private property rights, is assumed to be optimal.[^1]

This idea is false: as we will see there are a vast number (in the usual mathematical formulation, infinitely many) possible outcomes in which there are no free lunches, each corresponding to a different allocation of rights and a different market equilibrium.

We will discuss the issue of income distribution when we come to Lesson 2. Before doing this, we will consider a variety of examples to illustrate Lesson 1.

[^1]: Hazlitt’s reasoning is reinforced, in many economics texts, by the description of the competitive market equilibrium as “Pareto-optimal” or “efficient”. These misleading terms are discussed here.

fn1: Hazlitt’s reasoning is reinforced, in many economics texts, by the description of the competitive market equilibrium as “Pareto-optimal” or “efficient”. These misleading terms are discussed here.

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  1. nickj
    July 18th, 2015 at 18:28 | #1

    I got lost at opportunity cost, afraid I’m not motivated enough to do the necessary homework.

  2. John Quiggin
    July 18th, 2015 at 18:44 | #2

    @nickj

    I’ve added some links which might help a bit.

  3. July 18th, 2015 at 19:24 | #3

    Would it be an unnecessary complication to say something about consumer’s and producer’s surplus? These after all provide the motive for trade, so they are essential to the story.

    Prices provide no information about surplus. The distribution problem cannot be reduced to the one about initial endowments and tastes. It also depends on the production function. It you have constant returns to scale (solar panels today), then competition tends to reduce profits and producers’ surplus to the normal level – independently of the distribution of stock ownership. Not so for any product constrained by a limited supply, such as oil or top-class sports. Ricardo’s theory of rent comes into its own. And you get classes: the owners of land versus the owners of factories or ships, and the owners of nothing.

  4. Ikonoclast
    July 18th, 2015 at 19:27 | #4

    I am going to come at this issue from a left-field angle. Imagine that a scientist-mathematician models the behaviour of the ball in a football match. Further imagine that his equipment senses only the ball and describes its movement in 3d space. Being a scientist-mathematician he is a little naive about “football” and it never enters his head that there are codes other than the one he knows about. Furthermore he doesn’t even really know the full rules of this code of football.

    He finally develops some elegant maths which models the ball’s behavior and allows him to assign probabilities and make predictions about its progress as it travels from point to point. However, as soon as this equipment and the derived maths are applied to another code (with different rules) then all his elegant maths fail. They longer make accurate probability assessment.

    Is not micro-economics in the same boat? It presupposes a set of institutional rules to the game (along with complex customs etc.) and then derives a theory. But the theory is institution-set specific as it were. Maybe another way of saying this is “Markets ain’t markets” meaning all markets are not the same. The cultural context matters, the institutional context matters, the production system matters, natural events matter and so on.

  5. Tom Davies
    July 18th, 2015 at 19:40 | #5

    “The second requirement ‘no free lunch’ requirement is” should probably read “The second ‘no free lunch’ requirement is”

  6. Tom Davies
    July 18th, 2015 at 19:51 | #6

    @Ikonoclast I’m not trying to be snarky, but I think that examples from economics rather than an analogy would be better for making your point.

  7. Donald Oats
    July 18th, 2015 at 22:01 | #7

    @Ikonoclast
    This is why mathematicians like to generalise, but in the context of economics, generalisation doesn’t necessarily imply going from micro to macro; for your footy, knowing that a single ball is in play is a fairly general observation, and the rule that (at most) one player can have control of the ball at any given moment of play, is fairly general rule.

    With regards to the post by Pr Q, all seems fine.

  8. Ernestine Gross
    July 18th, 2015 at 22:52 | #8

    Comptetitive equilibrium #6 (treading first line as a paragraph):

    “As we saw then, this condition requires that all production be technologically efficient. If not, there is always a free lunch to be had by making production more efficient, producing less with the same inputs.”

    Shouldn’t this be ….producing more with the same inputs?

  9. Ernestine Gross
    July 18th, 2015 at 23:13 | #9

    # 9 and 10.

    Something doesn’t seem to be quite right with these 2 paragraphs.

    1. I can’t see why the relative market price difference between a jacket and tickets leads to an asymmetric treatment of the role of a market price in sgnalling there are other buyers and sellers of each.

    2. There is an implied assumption about endowments, be it monetary wealth or other objects that could be traded.

  10. BilB
    July 19th, 2015 at 00:37 | #10

    To your preamble sentence 2, consider a situation where a long term stock pile of shipping containers is madd available to homeless people as accommodation. There is no cost anyone, only benefits. The container stockist gets a warm media fuzzy, the homeless get more secure and reliable accommodation, the mobile soup kitchen can service more customers from one location. Does your argument hold true?

  11. Ikonoclast
    July 19th, 2015 at 07:18 | #11

    I am not quite sure where this proposed book is going and whether it will eventually support or oppose the argument for microfoundations of macroeconomics.

    As regular readers here will know, I oppose any view that microeconomics constitutes the totality of economics. I advocate the view that Economics properly understood at the societal level is Political Economy (very roughly, macroeconomics).

    The following paper is useful, in my opinion, in providing out outline of “A Sufficient Reason for the Necessity of Macroeconomics and the Futility of Microfoundations.

    http://www.landecon.cam.ac.uk/research/real-estate-and-urban-analysis/centres/ccepp/copy_of_ccepp-publications/YIANNISTHANOSPAPERFNL2.pdf

    So I have to admit to a bias which predisposes me to dismiss as largely useless, and even ideologically motivated, the entire microeconomic project. In this bias I no doubt go too far. There will be “zones” and levels in the economy and perhaps especially within certain kinds of markets where microeconomics is very useful.

    I mentioned earlier that I oppose any view that microeconomics constitutes the totality of economics. Equally, I oppose any view that market behaviour constitutes the totality of economics. Now, J.Q. might not be making the arguments that I here note myself as opposing. But this is how it comes off at first sight to me. I do wonder who is the target audience of his book and what is its final thesis.

  12. Ivor
    July 19th, 2015 at 11:51 | #12

    I find this confusing.

    competitive equilibrium prices both reflect and determine the opportunity costs

    Once A determines B, then B will always “reflect” A.

    Why not deal with reflection as a later effect and deal with initial determination?

    In any case …

    Is it: “competitive equilibrium prices determine the opportunity costs”

    or do: “opportunity costs determine competitive equilibrium prices”

    Trying to analysing prices via opportunity costs is weak because there is no consistency whether opportunity costs are based on marginal benefits, net benefits, relative benefits or total benefits.

    In the end, sellers do not bear any opportunity costs. They are entirely compensated by the opportunity benefits they receive from selling. The motive of maximising profits completely subsumes any concept of opportunity costs.

    When you consume food – you satisfy a need, you do not compare the opportunity costs of some other alternative activity.

    When you put petrol in your car – you are driven by need more than judging whether your dollars are better spent on a pizza.

  13. Jordan from Croatia
    July 19th, 2015 at 17:40 | #13

    I am with Ivor on this: do
    a) opportunity costs create competitive equlibrium or
    b) competitive equilibrium is necessery for realisation of opportunity costs?

    This topic definitevly requiers behavioral economics to be included. How marketing changes a desire for something: game tickets
    And how long established public institutions change prices so as to be considered competitive prices: existence of decades of public housing financials like Fanie Mae changed the price and quantity of housing
    public schools changed competition for education prices
    health care, utilities, and any long existing public programs change competitive equilibrium relations

    Also i did not discover the purpose of this theme book writing yet, maybe only a hint of it in how public actions change markets and should it be done. Should public actions meddle in “free market”? Pr. Quiggin, Is this the purpose of this book you write now?

  14. Julie Thomas
    July 19th, 2015 at 17:48 | #14

    PQ “As we saw then, this condition requires that all production be technologically efficient. If not, there is always a free lunch to be had by making production more efficient, producing less with the same inputs.”

    Should that be producing more with the same inputs?

  15. Jordan from Croatia
    July 19th, 2015 at 17:51 | #15

    @Jordan from Croatia
    Also the use of buffer stock in stock market trading i.e. derivative trading for farm and oil products change wild fluctuations of such prices disturbing the real time competitive equilibrium.

    There are no prices in todays world that reflect real competition due to long standing institutions that changed them to better reflect the necessities versus luxuries of living which was the purpose of establishing such insttitutions by public in the first place.

    In time those purposes got twisted and forgotten so the question is; does public institutions sti?l achieve those goals they were created for?

  16. John Quiggin
    July 19th, 2015 at 20:24 | #16

    @Julie Thomas

    D’oh! Will fix this straight away.

  17. Ikonoclast
    July 20th, 2015 at 09:10 | #17

    “If not, there is always a free lunch to be had by making production more efficient, producing less with the same inputs.”

    These mistakes seem to happen when one is tossing up two ways to express the same thought in the process of writing.

    Exhibit A: “If not, there is always a free lunch to be had by making production more efficient, producing more with the same inputs.”

    Exhibit B: “If not, there is always a free lunch to be had by making production more efficient, producing the same outputs with less inputs.”

    It’s good to be aware of this during re-writes as you can then choose which form expresses the central idea better and/or which feels stylistically better.

  18. Julie Thomas
    July 20th, 2015 at 11:20 | #18

    @Ikonoclast

    Did you see this bit from PQ’s post?

    “What I’m trying to do here is to spell out the logic underlying these results in a way that foreshadows the discussion of market failure and income distribution, in Lesson 2, but still shows the power of market mechanisms. I’ll probably need a few goes at this, and this is my first try.”

    And Ernestine, I see you already pointed out the ‘wrong’ word before I did. I wish I had read your comment before I spent a few minutes panicking that I had totally misunderstood all the economics I thought I had picked up over the last few years of hanging out here. Phew.

    The sentence was interesting because I can’t fit my ‘production’ of hats into the idea that I could be more efficient. When I tried once to make them using a production line process, I did produce more per week, but the products did not sell as fast, so presumably they were not as ‘valuable’ to the people who choose to buy my hats. They seem to lose something of the quirkiness and originality that is what my customers value.

    I had to sell them for less.

  19. Ivor
    July 20th, 2015 at 11:59 | #19

    @Julie Thomas

    The sentence was interesting because I can’t fit my ‘production’ of hats into the idea that I could be more efficient. When I tried once to make them using a production line process, I did produce more per week, but the products did not sell as fast, so presumably they were not as ‘valuable’ to the people who choose to buy my hats. They seem to lose something of the quirkiness and originality that is what my customers value.

    I had to sell them for less.

    Classic.

    The only people who benefited was whoever sold you the extra equipment and energy you needed to create the production line.

    Take home message – infrastructure spending does not necessarily create growth.

  20. Nevil Kingston-Brown
    July 20th, 2015 at 12:23 | #20

    * JQ’s argument (which I broadly agree with) seems to beg the question in this case from a neoclassical viewpoint – the begging being contained in the word “existing” which implies there is no transfer of property rights other than through state action. If there are competitive markets in factors of production or private property rights themselves, then (according to the premises of the opportunity cost etc argument) initially random or irrational allocations of private property rights (e.g. through hereditary wealth) would themselves be traded to people who can make more efficient use of them until a production frontier where there really is NSTAAFL is reached. So the argument that there are lots of different distributions of property with different NSTAAFL production frontiers is internally inconsistent.

    * A similar argument has been made in response to Picketty by Tyler Cowen and others, who argue that if capital really is becoming as concentrated as Picketty says, then the price of capital relative to labour should fall, implying a rising real wage. Again, given the premises (capital and property rights are tradable market goods like any other) this seems to follow.

    * From a hard left viewpoint, this sort of circular argument/causality is why Ricardo and Marx and then the neo-Ricardians turned away from market pricing as an explanation except for day-to-day fluctuations around a centre of gravity determined by the conditions of production/labour content; later formalized in Sraffa’s “Production of Commodities by means of commodities” model, and similar input-output models by Von Neumann, Leontieff, etc.

    * I mention this because this neo-Ricardian tradition explains the problems above – there is no such thing as “Capital” as a single tradable good (the Cambridge Capital controversy), and there exist market-clearing prices for any distribution of surplus (e.g. above reproduction requirements) income between workers, capitalists and landlords. For people from these economic schools, JQ’s revelation of Sraffian indeterminacy between allocations of property rights is old news.

  21. July 20th, 2015 at 13:25 | #21

    @John Quiggin

    “Similarly, firms can maximise profits only if the prices of the goods they produce are equal to the opportunity cost of the resources that could be saved by producing less of those goods.”

    We can see the biggest failure of this in terms of oil price which is actually cheaper than the past few years even though the globe is still warming up (yes, according to the IEA, global carbon emission fell thanks to China but the trend of warming is still on the rise). Technically speaking IF the extreme point of climate change is extinction of human which economics base the utility function on, then the price of oil (taking into account of externality) should rise exponentially as the global temperature rises.

  22. Julie Thomas
    July 20th, 2015 at 13:46 | #22

    @Ivor

    I’m too poor to make capital improvements – is that the right word? – unless it comes from the op shop. 🙂 and I’m not actually making a living from making hats.

    To be more efficient, I organised the cutting and sewing for a batch of 5 hats at a time, rather than doing one hat at a time and that did improve my output but doing things this way meant that the 5 hats all looked too much alike.

    Perhaps I could make more money from making these less pleasing one-offs and selling them at a lower price but my choice was to go back to making fewer hats that are clearly ‘mine’ and have integrity, – yes hats do have integrity – and work on building my reputation and that way selling them at a higher price as they become more ‘popular’.

  23. Ivor
    July 20th, 2015 at 13:57 | #23

    @Nevil Kingston-Brown

    Ricardo and Marx and then the neo-Ricardians turned away from market pricing as an explanation except for day-to-day fluctuations around a centre of gravity determined by the conditions of production/labour content

    Hardly – but it would derail this thread to go into detail.

    Marx was a market socialist as a first stage to higher civilisation.

  24. O6
    July 20th, 2015 at 13:57 | #24

    “If not, there is always a free lunch to be had by making production more efficient, producing more with the same inputs.”
    Is there in general a free lunch to be had? Julie Thomas’s example of a ‘glut’ is a good one.
    If demand exceeds supply and more can be produced for the same, there may be a super-profit, but this is not certain.
    Is Jevons’s paradox hidden somewhere inside?

  25. Newtownian
    July 20th, 2015 at 16:07 | #25

    There is a large branch of economic theory devoted to proving results of this kind using formal mathematics. But the core of the idea may be approached using the idea of ‘no free lunches’ or, more precisely, ‘no benefits without equal opportunity costs’, discussed in the previous section.

    John, could you clarify what you mean by ‘prove’ and right some of my misperceptions. [At the risk of repetition I am probably of a similar mind to Ikonoclast i.e. trying to understand economic thinking coming from what I understand to be the current hard ‘scientific’ method’.

    1. In hard science we dont strictly ‘prove’ anything these days. And we certainly dont use mathematics to ‘prove’ a science. So what does this mean in the Economic context? Is it the same as in hard science or a different beast more akin to rationalization – which is my concern.

    Science uses mathematics to develop models which a. account for the facts as best we are able to determine and b. make reliable useful predictions. But the maths dont ‘prove’ the science. The almost cliched example is Newtonian physics. It is now accepted as conceptually wrong. But the models developed are still useful and used practically for example for setting course of the Pluto probe.

    Maths is extremely useful model construction, integrating lots of disparate information and making very precise predictions/ extrapolations. Its also excellent for defining what we belief are the relationships between well established theories and measurements. Or you can let the program define the relationships.

    But math doesnt provide ‘Proof’. What is conceived in the vernacular as ‘Scientific proof’ is more a case of a collection of observations and extrapolations which strongly (often with statistics) support one or a collection of hypotheses so that scientists are comfortable arguing that this is the best available explanation.

    2. A somewhat subtle aspect of this process is the matter of whether a mathematical model is empirical or mechanistic. Increasingly its possible to come up with alternative models with similar predictive power but very different structure. I invite you to explore the wonderful world of Bayes and data mining to see how the same data can be consistent with multiple models and hence why there is a need for extreme caution in picking one model over another and claiming it is a ‘Law’.

    So how well do economists apply ‘humility with responsibility v. reinforcing their prejudices (which I hasten to say scientists can fall victim to as well). Could you perhaps explain the economist mindset whereby (you and?) your colleagues ‘prove’ such things as equilibrium models.

    3. I understood economic equilibrium theory came from chemical equlibrium theory but the diagrams used by economists seem to bear no resemblance to chemical equlibrium equations founded in concepts of thermodynamics and energy conservations.

    Another thing to be said about chemical equlibrium such reactions only last as long as some distrubing force is absent. Catalysts, new chemical species, electromagnetic radiation, heating, contaminants, phase changes, surfaces, microorganisms all dramatically impact on real world chemicals. Does economics have serious ideas about how these impact and can really be controlled sufficient to satisfy the skeptical mind?

    4. A final note on the dangers of using mathematics to ‘prove’ anything is this wonderful story by Freeman Dyson about how he, one of the scientific greats, in fact fell foul of this trap. DYSON, F. 2004. A meeting with Enrico Fermi. Nature, 427, 297-297.

  26. John Quiggin
    July 20th, 2015 at 19:39 | #26

    @Newtownian

    Mathematicians prove theorems, that is, logical deductions from premises. There’s a whole body of maths called proof theory about what this means. What can’t be proved is that a particular set of premises actually applies to a real-world problem.

    Economic concepts of equilibrium have little if anything to do with chemical equilibrium and are much closer to physics (statics and dynamics).

  27. Ikonoclast
    July 20th, 2015 at 20:21 | #27

    Didn’t Popper mention that there were conventional truths, logical or axiomatic truths and empirical or scientific “truths”? The last one has to be put in quotes as it really means something like “high probability of being true”.

    A conventional truth is that the man who runs this blog is named John Quiggin or that we drive on the left side of the road in Australia. These things are true by convention and common useage. I won’t give definitions for the other truths here.

    The interesting issue for Popper and many others was why is mathematics able to refer to reality successfully? Of course, it’s only a subset of maths that more or less refers to reality. Plenty of other maths deals with imaginary numbers, extra dimensions and so on. Yet these techniques too have their uses.

    To my thinking, I guess that a better description of economic general equilibrium maths (about which I actually know nothing) would be that it is an attempt to model the behaviour of certain real world systems (markets) or at least model certain idealised forms of these real world systems.

    Again, I believe (and can only believe without knowledge in this area) that these models could be useful for discovering certain possible or technical aspects (I am guessing) about markets. I don’t believe that these models are anywhere near being useful for managing full political economies, if they ever could be. But as I say these are just unsubstantiated beliefs or guesses on my part.

  28. Wylie Bradford
    July 20th, 2015 at 22:41 | #28

    John,

    Isn’t there a real problem with statements like:

    “This more complicated version of the story can be formulated in mathematical terms to show that, under the stated conditions (and some additional technical requirements), a competitive equilibrium will arise in which there are no free lunches; that is, any potential benefit entails an opportunity cost that is at least as great”?

    The sticking point for me is the word ‘arise’ which implies that there is a robust and general story to be told in theory about convergence to competitive equilibrium from an arbitrary starting point. But what exactly is that story? Walras recognised the problem and it isn’t clear to me that the neo-Walrasian program has yet provided the solution. Logically, statements about the *properties* of a competitive equilibrium are unconnected to the question of whether such an equilibrium can be *attained* in a given economy. Proving that under certain (immensely restrictive!) circumstances it can be shown that a price vector exists that would support trades that lead to allocations that have the ‘no free lunch’ property does not establish that such a vector could be realised through trade at non-equilibrium prices.

    Assuming that one follows from the other is question-begging on a grand scale (a point Frank Hahn made a lot in his fight against Lucas et al), and a vice of Hazlitt and his ilk. It certainly (and unfortunately) seems to undermine your argument in a serious way. Austrians, of course, are able to retain the rhetoric of market *processes* without the GE apparatus but I doubt that that’s a direction you want to go.

  29. Andrae
    July 21st, 2015 at 08:52 | #29

    I’ve been reading Stiglitz recently, and he seems to require two assumptions for market equilibrium that I don’t see in your text: That markets be complete, and that markets clear. I don’t pretend to be an economist, so these may be implicit in the OP, but I would be interested in understanding how these affect your reasoning?

  30. John Quiggin
    July 21st, 2015 at 12:21 | #30

    @Andrae

    These are both in (A). “Complete” means “for all goods and services” and “markets clear” means “everyone can buy or sell as much as they want to at the prevailing prices”. I’ve spelt out what Stiglitz says in economist shorthand.

    @Ikonoklast I’ve tried to say in the preface that I won’t be claiming micro (at least not the neoclassical micro underlying GE) as the foundation for macro

    @Wyile I am approaching this as a response to the Austrian approach which is implicit in Hazlitt. So, I’m not going to worry about neoclassical theory questions like existence, multiplicity, convergence etc. Rather, I’m going to respond to the Austrians on their own terms.

  31. Ikonoclast
    July 21st, 2015 at 18:44 | #31

    This is probably off-topic. I read an online essay by some economist (forget his name already) and he was basically arguing the old “society doesn’t exist, only individuals exist” line.

    If I was in a room where anyone said that I would heckle: “Individuals don’t exist, only atoms exist.”

    The thing is, if you want to deny emergent phenomena, they have to go far more reductionist than simply denying that society exists. Heck, even atoms don’t make the cut of existing if society doesn’t make that cut.

  32. Julie Thomas
    July 22nd, 2015 at 08:54 | #32

    Ross Gittens knows what opportunity cost is.

    “Put at its simplest, the concept of opportunity cost says that if you’ve got a dollar, you can only spend it once. This truth might be glaringly apparent, but it’s surprising how often grown men (and, less commonly, grown women) forget it.”

    http://www.smh.com.au/comment/increasing-gst-a-fanciful-fix-for-strained-budgets-20150721-gigv1o.html#ixzz3gZLa5eCe

    Ikon, I read someone else say to those who still love the idea of the magnificent individual that there are no individuals; there is only society.

    How is it possible to be ‘an individual’ without other people? It’s the same thing as the tree in the forest making no noise if there is no person to hear it.

  33. Wylie Bradford
    July 22nd, 2015 at 10:17 | #33

    @Ikonoclast

    The ‘no such thing as society’ view might be recast in terms of the problem of defining social welfare. Arrow’s General Possibility Theorem shows the intractable difficulties associated with defining social preferences via aggregation of individual preferences. Hence much blithe talk of social welfare on that basis is actually incoherent, there being no way to define ‘social welfare’, let alone measure its ups and downs. You could decide to try to define social welfare on a basis other than individual preference satisfaction, but that is still open to the Rylean question: once we have identified all individuals and the institutions with which they interact, where is the separate thing called ‘society’ that is an agent experiencing welfare fluctuations?

  34. jrkrideau
    July 23rd, 2015 at 01:41 | #34

    The closest I ever got to economics was dating a economics student so this is likely stupid but if we have the conditions that Prof Quiggin sets up: Given TANSTAFL applies then presumably no one can make capital gains money on the stock market? Or it seems anywhere else.

  35. Ikonoclast
    July 23rd, 2015 at 07:33 | #35

    @Wylie Bradford

    Once we have identified all atoms and the chemical bonds they make when they they interact, where is the separate thing called a person that is an agent experiencing welfare fluctuations?

    Once you, in a theoretical or thought-experiment manner, pull a complex system apart into “component pieces” you no longer have the complex system you began with. This is axiomatically and trivially true. Such thought experiments prove precisely nothing.

  36. Ikonoclast
    July 23rd, 2015 at 08:01 | #36

    “The market is a radical experiment which violated fundamental human needs and capacities. You can see this in the violent struggles that were required to impose market conditions on people. In the United States, for example, about one sixth of the gross national product, over a trillion dollars per year, is devoted to marketing. Marketing is manipulation and deceit. It tries to turn people into something they aren’t — individuals focused solely on themselves, maximising their consumption of goods that they don’t need.” – Noam Chomsky.

  37. Wylie Bradford
    July 23rd, 2015 at 10:02 | #37

    @Ikonoclast

    Let me first stress that I do not endorse the ideological overtones of the classic ‘there’s no such thing as society’ discourse, involving as it does a methodological reductionism that is untenable. I’m pretty sure we’re in agreement on that score.

    That being said, you might want to point out how you avoid the regress in your counter-argument – ‘atoms’ haven’t been a viable stopping point for a long time in physics terms. One might find oneself ultimately arguing that nothing exists. The line about complex-systems is also somewhat question-begging. The context in which statements are made is important. Even though we are both made up of the same stuff I presume you agree that while you and I can talk to each other (as we are now) there is no sense in which ‘Australia’ can talk to ‘France’ in the same way.

    I focused on welfare questions for a reason, a reason that renders your remarks about the person beside the point. Often there is an ascription of welfare to ‘society’ (social welfare) that proceeds from an analogy to individual welfare. That is what I identified as deeply problematic and since there is no analogy drawn between the relevant properties of the person and the properties of their constituent atoms (e.g. atoms aren’t sentient and don’t experience welfare changes) the comparison is invalid.

    “Society’ is a perfectly useful portmanteau term for ‘all individuals and the institutions with which they interact’ just like ‘team’ is for a collection of players and staff and administrative structures and orchestra for a collection of musicians and associated staff and administrative structures. Factual statements made on that basis are fine e.g. ‘the team toured Europe on a bus’, ‘the orchestra has widened its repertoire’ and ‘Australian society has become more ethnically diverse’. But faced with the statement ‘the orchestra is happier now compared to last year’ we’re entitled to ask exactly what is meant by that. Is it some statement about average happiness (measured somehow) of the musicians and other staff? What it can’t be is a statement about the happiness of the orchestra qua agent separate from the individuals that comprise it as in that sense (not every possible sense) there is no such thing. Ditto ‘there’s no such thing as society’ is an adequate response to claims that society is better or worse off that presuppose the existence of ‘society’ as a separate welfare-experiencing agent.

  38. Ikonoclast
    July 23rd, 2015 at 14:34 | #38

    @Wylie Bradford

    Overall I get your drift now and we seem to be on the same page. Our seemingly different positions might be a difference in emphasis.

    I agree that for reductionism purposes “‘atoms’ haven’t been a viable stopping point for a long time in physics terms”. I had typed some more text and then deleted it. I didn’t want to reduce matters further because I would have fallen foul of “Plasmaatron’s Law”. The commenter on this blog called plasmaatron (spelling?) justifiably accuses me of “theory dropping” if I mention quantum theory or worse, string theory, when I have no real scientific or mathematical grasp of either.

    You say “But faced with the statement ‘the orchestra is happier now compared to last year’ we’re entitled to ask exactly what is meant by that.”

    However, if there was a village with badly undernourished children and adults and a government or charity assisted with food aid as well as longer term water and farming projects then in one year we could very likely say accurately. “The village is better nourished now compared to last year.”

    Admittedly, we mean the people of the village not the entire village as such (as a collection of people and infrastructure etc.). I think the issue gets a bit semantic. When we use collective nouns like “village”, the context often enables us to determine whether we mean people or collections of things or both.

    “The village is better nourished.” is understandable though it might be better English to say “The villagers are better nourished.”

    “The village is less dilapidated”, would probably alert us we were talking about huts, houses, tracks, fences and so on.

    I use “nourished” as an example because good nourishment is a welfare goal more amenable to objective measures than happiness.

  39. Ikonoclast
    July 23rd, 2015 at 15:24 | #39

    It doesn’t take a market to create a free lunch. IDTAMTCAF.

    I think the effects of markets are over-emphasised and over-estimated in our system. To my mind, the market is a second order phenomenon at best. The first order phenomenon is production. Without production there can be no consumption and no market.

    I will make a needed detour and then come back to the point. I tend to think of “society” in sociological terms. We humans live in society with our fellows. This means we live in association and it specifically means what could be called the “four Cs”: closeness, communication, cooperation and competition.

    In some ways, “closeness” can just be “proximity” and proximity itself is now technologically mediated. Distant humans can be brought “close” in certain ways at certain times with technology.

    “Competition” also requires some comment. Most human competition in society (or in a city, a nation or the globe if you prefer) occurs within a rule-based system. Thus there is a cooperative level or phase which occurs first and which lays down the rules and the institutions of competition. This is true for games and business, for cricket or competitive tendering or general market place competition. Rule-less competition is very rare. Total war without any rules of war is the only situation I can think of where there would be completely rule-less competition between two groups. Each group nevertheless would have to obey cooperative rules internal to their own group in order to successfully prosecute total and rule-less war against another group.

    Coming back to IDTAMTCAF (It doesn’t take a market to create a free lunch).

    Have you ever painted house exteriors by yourself? If, like me, you have done so you will have realised things like this. Planks and trestles are very unwieldy objects even if they are not particularly heavy for the average man. Moving and re-setting trestles and planks by yourself in a crowded obstacle field of a house yard (trees, shrubs, carports, window awnings, gables, finistrations etc.) is an awkward, time-consuming business. So is running up and down trestles when you forget something or drop something.

    If two solo painters each paint a house alone (and even leaving aside the fact that they will need to buy or hire two plank/trestle kits, one set each) they will each have relatively slow, awkward time of it. If they work together, the jobs speed up. Each house takes less than half the time once two are painting it. Re-setting trestles and planks is quicker. Retrieving and passing up items is quicker. One painter can finish applying one pot while the other mixes the next batch and so on.

    When it comes to items being carried: Imagine a work site relying on human carrying ability. A certain item may be too heavy for one man to lift (even one end). Yet four men may successfully carry and place these items. Thus the increase in productivity is infinite in going from a one man work team to a four man work team. Here we have an infinite increase in productivity and nary a market in sight. By the way, these are Amish men so there is no market for their labour. 😉

    This will sort of illustrate why I think markets are a second order phenomenon.

  40. John Quiggin
    July 23rd, 2015 at 16:50 | #40

    @jrkrideau

    Given TANSTAFL applies then presumably no one can make capital gains money on the stock market? Or it seems anywhere else.

    That’s pretty much what the standard version of the model says. I’m not aware of any version of the model that explains the massive returns to financial market operators.

  41. rog
    July 23rd, 2015 at 17:38 | #41

    Capital gains should be made by decreasing inefficiencies – producingu more with the same inputs.

    Analysing inputs seems to be an almost impossible task; Benoit Mandelbroit said that financial markets are driven by “wild randomness”.

  42. Ikonoclast
    July 23rd, 2015 at 19:20 | #42

    A couple of quotes from John Ralston Saul:

    “[T]he free market may be a good, bad or insufficient idea, but, in any case, it is just a crude commercial code. Now it is regularly equated with or given credit for or even precedence over the freedom of man. But the freedom of man is a moral statement on the human condition, both in the practical and in the humanist sense. To equate it with a school of business is to betray a certain confusion. An unconscious unease.”

    “[Modern capitalism] is masterful at producing services people don’t need and in large part probably don’t want. It is brilliant at convincing people that they do need and want them. But it has difficulty turning itself to the production of those services which people really do need. Not only that, it often spends an enormous amount of time and effort convincing people that those services are either unrealistic, marginal or counterproductive.”

  43. Ikonoclast
    July 24th, 2015 at 12:12 | #43

    I put this post below in the wrong thread. This is the right thread I think.

    Perhaps J.Q. or other supporters of “the market” can tell me how “Automobile Capitalism” was ever efficient in any sense. By “Automobile Capitalism” I simply mean the adaptation of our society, circa 1950 to the present, to entirely suit the automobile’s needs via cityscapes, roadscapes, landscapes, factories; indeed our whole built infrastructure, transport structure and production system. How was this “efficient” in any sense? (Except one trivial, worthless sense which I will come to.)

    1. Mass transit is more efficient economically and in energy/material terms.
    2. It (automobile culture) has contributed seriously to climate change.
    3. Injuries and fatalities were and are far higher than with other mass transit systems.
    4. Excessive amounts of land were and are devoted to automobile use.

    I could go on. There is no way that one can argue this was an efficient outcome unless one uses the flawed criteria that economic efficiency is building a lot of stuff with less resources than other methods whilst at the same time ignoring the needlessness, uselessness and even seriously damaging nature (to humans and the biosphere) of much of the stuff actually being built. Only by ignoring this huge flaw in its own logic can the “market economy” under really existing capitalism, claim efficiency for itself. Indeed, just about the only thing it has been efficient at is wrecking the planet and impoverishing third world people and others who suffered and suffer from imperialism and its successor systems.

  44. Avi
    July 26th, 2015 at 20:33 | #44

    Any plans for a section/chapter on endogenous growth?

  45. Nevil Kingston-Brown
    July 28th, 2015 at 11:36 | #45

    @John Quiggin
    Does “complete” include markets for capital goods and property rights? Because as I stated above your formulation seems to imply that inefficient owners of rights will not sell to more efficient potential owners of rights.

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