Thursday, February 2, 2012

Probably a dumb question...

... but it seems like various things I think about lead me back to it from time to time, so it's worth asking: "what reason do we have to expect that a market economy will operate at its full potential?"

And to clarify, I think in a lot of cases the market economy does operate at close to its full potential. I don't doubt that's the case. I think it's just important to have a sensible answer to the question of why it does.

If the answer is of the "people don't leave profit opportunities unexploited" variety, I think I accept the premise but not the conclusion. It's true. People don't leave profit opportunities unexploited. But this just turns it into a chicken-and-egg problem. Profit is revenue minus cost. Revenue is what people are able and willing to pay for a product in the market. Let's assume for the sake of argument that our wants are unlimited, but our ability to satisfy those wants clearly isn't. So the existence of a profit opportunity to exploit is contingent on ability to pay.

So what guarantees that ability to pay is such that profit opportunities are such that the market economy will operate at its full potential?

Since ability to pay is a question of income, and since income and output are the same thing in the aggregate, we're right back to the same question we started with.

As I've said before, Say's Law properly understood and with allowances for hoarding and such certainly has its uses. Someone unconcerned with the caveats and qualifications can even say that Say's Law guarantees a balance will be struck between supply and demand.

But I'm not sure why I should care about that balance in and of itself. Say's Law says nothing about whether the balance will be struck at a full employment level.


  1. People are always "fully employed," employed in pursuing the best options available to them.

    The free market, in a 'first best' sense, maximizes the number of opportunities created and pursued (i.e. trades). Here the 'second best' would be regulators foreclosing opportunities either directly or by deadweight losses.

    Whether or not this collection of 'first best' opportunities would include a higher % in formal labor would be indeterminate.

  2. My difficulties with Daniel's view here start with the idea of "full potential". Can someone define exactly what it is?

  3. I think "Anonymous'" point is dangerous: "People are always "fully employed," employed in pursuing the best options available to them."

    The question is: who cares, or what are the implications? Does that mean we shouldn't worry about mass unemployment? Does that mean that the market is maximizing employment when its burdened by regulations? Is Mali's economy acting as efficiently as the United States'?

    1. yeah, the unemployed could become 'entrepreneurs' by getting a gun and pursuing a career in armed robbery...

      You can attempt to define away a problem but sometimes it comes back to you in high velocity lead format...

  4. @Catalan,

    Bingo. Full employment could entail digging holes and filling them at gunpoint, given the right institutional incentives.

    My point being that employment itself is not a good. The question is how well that employment satisfies wants.

  5. Sorry, I feel like I criticized Daniel's question instead of answering it in his terms. So here goes:

    you can raise employment by decreasing consumption or by increasing how resources are employed in trade. That is, your enemy is workers watching sitcoms and cooking their own dinner.

    In theory, I don't see why tweaking endowments couldn't decrease sitcoms and home cooking. My sense is that, for public choice reasons, these tweaks will tend to decrease trades through aforementioned bans-or-deadweight. That is, by messing with the market mechanism, fewer good jobs will be available, leading workers to spend more time watching sitcoms. Meanwhile, myriad regulations will make take-out more expensive vis-a-vis home cooking. Result is more consumption and less trade. Both should decrease productivity.

    So, in theory, I agree tweaking can increase employment. In practice, I think it decreases it.


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