Monday, September 12, 2005

Markets Are Useful But Not Magical

by Tom Bozzo

Max Sawicky takes on a host of conservative expressions of love for price gouging in the name of "market clearing." I highly recommend clicking through to Max's exposition.

One small irony of local interest apparently missed in the lengthy comments exchange is that among points raised by coif-for-brains John Stossel was a claim that some wage premium to attract Cheesehead carpenters to the disaster zone to participate in the reconstruction effort. He obviously didn't get the memo on that one. A Good Catch award goes to my friend Oscar, who notes that while using the buying power of the Federal reconstruction effort to undermine wages, Bush issued "no order limiting contractor profits for the same work."
Since the market is truly efficient, the winning bidder on all reconstruction contracts will pay submarket rates and pass those savings on to the government in the form of its competitive, lowest-but-still-viable bid.

(/channeling Jane Galt)
If the market were truly efficient, the contractors should be no more able to offer "sub-market" wages than gas stations could "gouge" at "above-market" prices. Thus, under perfect competition, the effect of suspending Davis-Bacon should be zero.

[/whatever mood is represented by my present state of undercaffeination]
Sawicky concedes that At most, you could say a modest premium over the price that provides the “normal” profit should be sufficient to remedy scarcities. You shouldn’t necessarily need complete price flexibility at which point the debate over price gouging is one over semantics: we all agree price should rise, it's just that some think there ought to be a cap on those rises, or something. And where is the line between an "acceptable" price increase and a "price gouging" price increase?

Like: I understand the point that it is appealing to market fundamentalism to invoke "market clearing" as this magical thing and that this is in general an intellectually lazy -- and at a minimum inaccurate, if not misleading -- thing to do, but I don't fully understand how these market imperfections add up to mean that there is some superior alternative.
Isaac: I understand what Max was saying in the section you're quoting to be that a temporary price spike due to a "stampede" probably won't signal producers to increase capacity. I think the basic intuition of the statement you quote is right: a la Dixit and Pindyck's Investment Under Uncertainty, which was state-of-the-art back in the stone age when I was in grad school, parameters of the price process, market demand, and investment cost will determine entry (and exit) threshold prices.

I should note that D&P derive some results that suggest that with prices following a Brownian motion (in continuous time), you can get some quite perverse results from price controls.

However, the stampede probably constitutes a switch in the price process that materially violates some of D&P's assumptions. My assertion w/o proof is that under such circumstances, you can set a ceiling that doesn't bind under the "normal" price process but which kicks in w/ a stampede. It may (probably) be necessary to have a rationing mechanism for that case -- tied, say, to a suitable declaration of an emergency. You're right to say that this isn't obviously a superior alternative, the design of the rationing mechanism mattering a lot... but then again, as Max notes, allowing prices to spike w/o bound doesn't guarantee that people who "need" gas will get it, either.
Indeed, the opposite would be more likely: those who can accelerate the buying decision do so, leaving those who cannot with less.

I note dryly and without malice aforethought that the bulk of the "spike" (in my area, the last 25 cents of an 85 cent rise) ended farily quickly after Labour Day, leading anecdotally to the conclusion that this was more a "take excess profits while you can" more than anticipation of production/supply issues (which were no more resolved a week later).
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