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From: carnes@gargoyle.UUCP (Richard Carnes)
Newsgroups: net.politics.theory
Subject: The free market
Message-ID: <206@gargoyle.UUCP>
Date: Fri, 4-Oct-85 20:09:51 EDT
Article-I.D.: gargoyle.206
Posted: Fri Oct  4 20:09:51 1985
Date-Received: Sat, 5-Oct-85 14:39:45 EDT
References: <204@gargoyle.UUCP> <10516@ucbvax.ARPA>
Reply-To: carnes@gargoyle.UUCP (Richard Carnes)
Organization: U. of Chicago, Computer Science Dept.
Lines: 74

In article <10516@ucbvax.ARPA> mcgeer@ucbvax.UUCP (Rick McGeer) writes:

>>>Finally, whether you call them "needs" or "demands", you're still
>>>talking about the allocation of scarce resources...which is done optimally
>>>in a free market.
>
>It is not well-known to be false.  See Alchian & Allen, or Hirschleifer.
>Or read Smith, or Pareto, or Hume, or Mill, or Ricardo, or Friedman (either
>one) or Stigler, or von Hayek.  Of all of history's great economists from
>Smith on down, only a very few would not argue this.  I am more than a little
>surprised that you would make this statement.  Most statist economists that
>I know would argue that, though the market was optimal, it did not
>address concerns of equity.
 
Correct me if I am mistaken, but to my knowledge none of the
above-mentioned economists makes the blanket and unqualified
statement that "the free market optimally allocates scarce
resources," unless perhaps in a textbook which makes oversimplified
statements for the consumption of students or as a rhetorical
statement which is not intended to be theoretically precise.  [BTW,
would some libertarian kindly define "statist"?  "Non-libertarian" is
not a helpful definition.  I would like to know the nature of the
crime of which I am accused.]

There are many situations that can be described in which the market
does not "optimally" allocate resources (let's assume for the moment
we all agree on what "optimal" means).  Here is a very simple one:

Let us say there is a town with owners of used cars and potential
buyers of the cars.  The cars vary in quality from great to lemons,
but only the owners know the quality of the cars.  A potential buyer
must assume that a used car he is looking at is of average quality,
and therefore he would only be willing to pay (say) $1000, the price
of an average used car.  But the only owners willing to sell at that
price are those with cars of below average quality.  The potential
buyers realize this, and so are not willing to buy any car that an
owner is willing to sell.  Hence there are no transactions, even
though such trades would be beneficial to both parties.  It is the
asymmetry of information that causes the market inefficiency.  It is
clear that such information asymmetries are common in markets.

I'm not saying anything that isn't well known to economists.  The
article on which this argument is based appeared in the *Quarterly
Journal of Economics* in 1970 (G. Akerlof, "The Market for Lemons").
Other well-known market inefficiencies are denoted by the terms
prisoner's dilemmas, ethical hazard, externalities, corner solutions,
and free riding.  I'll elaborate on these later on if I have time.  

In addition, reasonable arguments can be made (I'll probably post
them to the net at some point) that minimum wage laws,
anti-discrimination laws such as affirmative action, and vouchers
(similar to M. Friedman's educational vouchers) for subsidizing the
purchase of basic necessities, can all, at least in some
circumstances, increase the efficiency of the marketplace.  Please
note that I am not now talking about *equity*; I mean *efficiency*.  

I agree that markets are extremely useful.  I am satisfied, unless
someone convinces me otherwise, that Arrow, Debreu, and Hahn have
shown that the market, assuming some stringent conditions such as
perfect competition, achieves a Pareto-optimal state.  But they are
discussing an abstract model, not the actually existing marketplace,
and in addition Pareto optimality is a very debatable standard for
optimality, since it does not address some distributional questions
that many people feel to be important in assessing social outcomes.  

My main point is that I object to Rick's dogmatic claim that the free
market optimally allocates resources without qualification and
without defining "optimality."  Yes, a certain model produces a
certain *kind* of optimality, and this is useful and important
information.  But the full story is far more complex than this, and
does not lead to the conclusion that the absence of government
intervention is the best policy in all circumstances.
-- 
Richard Carnes, ihnp4!gargoyle!carnes