On 5/11/06, tfast <tfast at yorku.ca> wrote:
> Hayek is indeed the place to start. He makes the argument that prices are
> an information signalling system. A very accessible paper is here: Hayek, F. A. 1945.
> "The Use of Knowledge in Society". ...
>
> Keep in mind Hayek was deeply involved in the socialist calculation debate
> which orthodoxy [?] lost. Hayek's paper listed above is his final rejoinder
> after the defeat. What is great about this paper is it sets out the core of
> contemporary propositions about the superiority of markets but is clever
> enough not to formally model the argument. ...
which orthodoxy is that? one of Hayek's debates (Lerner?) favored the use of a central planning agency that set prices. That was hardly "orthodox" at the time or now, among socialists or even neoclassicals.
Anyway, the idea is that prices "convey" information. If I say that I am willing to pay $100 for a massage (something I need right now), that "demand price" is signalling in the market that not only that I am willing to pay $100 but that I have the purchasing power with which to do so. On the other hand, if a masseuse/masseur is willing to take $100 for a massage, then that "supply price" signals the costs and availability of the massage technician (as it were). In a perfectly competitive market, the equilibrium price will reflect the lowest possible demand-price (what the person least wanting and able to pay for a massage is willing to pay) given supply constraints and the highest possible supply price (what the person least willing to give a massage will accept) given demand constraints.
The problem, of course, is that the signals typically do not signal either the benefits of the service or its costs accurately. Therein lies the rub.
1) as Arrow (among others) pointed out, prices signal only individual wants, not societal values. Politics is needed to express the latter.
2) the price does not reflect the true benefits and costs of the product.
a) The fact that my wife and son might benefit from my being in a mellow mood is not reflected in my willingness to pay for the massage unless we communicate with each other successfully (hopefully using non-market methods). The demand price misses the external benefits of the massage.
b) The cost of the fact that having a bunch of massage parlors around makes a town look sleazy (e.g., Berkeley in the 1970s, when I lived there) is not reflected in the supply price. The supply price, in other words, misses the external costs of the massage. (It's possible that it was _I_ that made Berkeley look sleazy, but that can't be true!)
I'm using trivial example, but this problem of external costs and benefits is really important since they are so ubiquitous. Pollution is a crucial issue. This says that markets (if they are used) have to be politicized rather than treated as a natural force which will automatically solve problems.
3) Recent economists (e.g., Akerlof, Stiglitz, coincidentally both winners of the "Nobel" prize) have applied an information-theory approach that undermines Hayek's celebration of markets. (I guess you could say that they hoist Hayek on his own petard.) For example, Akerlof points to the problem of _asymmetric_ information and "adverse selection."
Suppose that a significant number of the masseurs and masseuses are criminals or carry communicable diseases -- but they don't reveal to the customers that they are this way (so that information is asymmetrical). Because of this -- and because people don't have sufficient information about the masseuses/eurs, the demand price would be depressed. The key point is that the market mechanism _does not solve the basic problem_ of asymmetric information. Instead, it makes it worse: with lower prices, it is the criminal and/or diseased masseurs/euses who stay in the market. The honest and clean massage technicians would look for other jobs. In the end, only the "bad" massagers would be left, confirming people's prejudice. The market suffers from a self-fulfilling prophecy.
It's called adverse selection (I believe) because it's unlike good selection. In the good selection of the main Darwinian story, the critters who are most adapted to the environment are most able to breed and have their kids survive to breed again, and so dominate. Adverse selection, on the other hand, is more like Darwin's "sexual selection" story. Female elk choose male elk with big antlers because they don't know how good the males are at producing survivable fawns. So the evolutionary process produces a bunch of elk who have a hard time navigating through the trees (and thus don't fit the environment very well).
Sean Andrews wrote: >one that Galibraith [sic], in one of his final editorials for Mother Jones, contested.) <
it's _James_ Galbraith, not the late John Kenneth Galbraith, who writes for MOTHER JONES, so I'm sure it wasn't one of his final contributions. -- Jim Devine / "the world still seems stuck in greed-lock, ruled by fossilized fools fueled by fossil fuels." -- Swami Beyondananda