Prometheus 6

Though I've taken a pause to watch DVDs, I'm still studying economics.

I've said before how impressed I am with Economics Explained: Everything You Need to Know About How the Economy Works and Where It's Going by Robert Heilbroner and Lester Thurow. Having finished it I feel like I have enough of a grip on the basic concepts to understand a discussion because I know which words are terms of art; to actually think about stuff I need a bit more.

At any rate, this post was inspired by a comment made about markets clearing.

How many of you know what "markets clearing" means?

I thought so.

I've scanned and uploaded a chunk of a chapter explaining what "supply" and "demand" are in microeconomic terms, a nice, bland HTML file. No graphs or anything; you have to get the book for that. But just in case you don't like links and such:

And the extended text has enough of the chapter to let you know where this is coming from.THE MARKET AS A RATIONING SYSTEM

Now look at what this shows us. All the buyers and sellers who can afford and are willing to pay the equilibrium price (or more) will get the goods they want. All those who cannot, will not. So, too, all the sellers who are willing and able to supply the commodity at its equilibrium price or less will be able to consummate sales. All those who cannot will not.

Thus the market, in establishing an equilibrium price, has in effect allocated the goods to some buyers and withheld it from others. It has permitted some sellers to do business and denied that privilege to others. Note that the market is, in this way, a means of excluding certain people from economic activity, namely customers with too little money or with too weak desires, or suppliers unwilling or unable to operate at a certain price. It is, in fact, a rationing mechanism!

Our view of the price system as a rationing mechanism helps to clarify the meaning of two words we often hear as a result of intervention into the market-rationing process: shortage and surplus.

In everyday language we often say that there is a shortage of housing for low-income groups-meaning that poor people cannot find housing that they can afford. Yet as we have seen in every market there are always some buyers who are unsatisfied. We have previously noted, for instance, that in our market for blouses, all buyers who could not or would not pay $19.95 had to go without. Does this mean there was a shortage? In economic terminology, no. A shortage in economic terminology does not mean there are no unsatisfied people in a market. It means only that no one who is willing and able to meet the going price is unable to get the goods he or she wants.

In a market that "clears," no such buyers exist. To be sure, there may be many would-be buyers happy to buy blouses at, say, $16.95, but there are none for sale at that price. Thus "shortage" only refers to buyers who are willing and able to pay the going price but who cannot get their demands filled at that price.

Why not? The answer must be that some nonmarket agency-in medieval times, perhaps the Church; in our day, more likely some government agency-has set the price below the equilibrium level. Now buyers who could not get blouses at $16.95 come crowding into the store-only to find that there are not enough blouses to meet the swollen demand. Who will go without-the buyers who were willing and able to pay the higher price, or the new "lucky" buyers who are now able to pay the lower price? The answer is queues in stores to buy things before they are gone, under-the-counter deals to get on a preferred list, or black or gray markets selling goods illegally at higher prices than are officially sanctioned.

The opposite takes place with a surplus. Suppose the government sets a price floor above the equilibrium price, for instance, when it supports the price of corn above its free-market price. In this situation, the quantity supplied is greater than that demanded. In a free market, the price would fall until the two quantities were equal. But if the government continues to support the commodity, then the quantity bought by private industries does not have to be as large as the quantity offered by farmers. Unsold amounts-the surplus-will be bought by government.

Thus the words "shortage" and "surplus" mean situations in which sellers and buyers remain active and unsatisfied because the price mechanism has not eliminated them from the marketplace. This is very different from a free market where buyers and sellers who cannot meet the going price are not taken into account. Most people, who have no demand for fresh caviar at eighty dollars per tin, do not complain of a caviar shortage. If the price of fresh caviar were set by government decree at one dollar a pound, there would soon be a colossal shortage.

What about the situation with low-cost housing? Essentially what we mean when we talk of a shortage of inexpensive housing is that we view the outcome of this particular market situation with noneconomic eyes and pronounce the result distasteful. By the standards of the market, the poor who cannot afford to buy housing are only one more example of the rationing process that takes place in every market. When we single out certain goods or services (such as a doctor's care) as being in "short supply," we imply that we do not approve of the price mechanism as the appropriate means of allocating scarce resources in these particular instances. Our disapproval does not imply that the market is not as efficient a distributor as ever. What we do not like is the outcome of the market-rationing process. In other words, for all its worth, efficiency is not the only criterion by which we judge the market system.

That word efficiency brings us to the last and perhaps most important aspect of how markets work. This is the ability of markets to allocate goods and services more effectively than other systems of rationing, particularly planning in one form or another.

There is no question that the market is one of the most extraordinary social inventions in human history. If we recall the attributes of the pre-market societies of antiquity we may remember that they typically suffered from two difficulties. If they were run mainly by tradition, they tended to be inert, passive, changeless. It's very hard to get things done in a traditional economy if anything has to be done in a new way-if, for instance, a change in climate forces a search for new ways of growing food or catching game.

A command system, ancient or modern, has a different inherent problem. It is good in undertaking big projects but not in running a complex system. In addition, the presence of political power in the economic mechanism, either as a large bureaucracy or as an authority capable of sticking its nose into daily life, becomes an endless source of inefficiency and irritation.

Against these two difficulties, the price system has two great advantages: it is highly dynamic, and it is self-enforcing. That is, on the one hand it provides an easy avenue for change to enter the system, as imaginative or ambitious individuals try new approaches or invent new goods. In addition, it allows these individuals to get a fair trial without first getting anyone's official permission: all you have to do is to sell your product!

The second (self-enforcing) attribute of the market is especially useful with regard to the rationing function. In place of ration tickets, with their almost inevitable black markets or cumbersome inspectorates or queues of customers trying to be first in line, the price system operates without any kind of visible administrative apparatus or side effects. The energies that must go into planning, or the frictions that come out of it, are alike rendered unnecessary by this remarkable self-policing mechanism. With all its difficulties, which we have by no means fully enumerated or examined, it is this capacity for self-adjustment and self-correction that sets economics apart from-although by no means above-its sister social disciplines.

That always comes as a surprise. We think of rationing as a formal, inflexible way of sharing goods-one ticket, one loaf of bread. This seems just the opposite of the free, unimpeded flux of marketplace. And in some ways it is indeed as different as can be. Just the same, the price mechanism performs a rationing function, exactly as do ration tickets. Money can be thought of as a system of flexible ration coupons. Indeed, there is nothing more important to grasp than this central purpose that markets serve. They are simply sophisticated rationing mechanisms.

On the other hand, the system has the defects of its virtues. If it is efficient and dynamic, it is also devoid of values. It recognizes no valid claim to the goods and services of society except those of wealth and income. Those with incomes and wealth are entitled to the goods and services that the economy produces; those without income and wealth receive nothing.

This blindness of the market to any claim on society's output except wealth or income creates very serious problems. It means that those who inherit large incomes are entitled to large shares of output, even though they may have produced nothing themselves. It means that individuals who have no wealth and who cannot produce-perhaps simply because they cannot find work-have no way of gaining an income through the economic mechanism. To abide just by the market system of distribution, we would have to be willing to tolerate individuals starving on the street.

Therefore, every market society interferes to some extent with the outcome of the price-rationing system. It does so when an "economic problem" crosses the line to become a "social problem." In times of military emergency the nation issues special permits that take precedence over money and thereby prevents the richer members of society from buying up all the supplies of scarce and costly items. In depressed areas, it may distribute basic food or clothing to those who have no money to buy them. Historically speaking, it has used taxes and transfers to an ever-increasing extent to replace the ration tickets of money in accordance with the prevailing sense of justice, rather than by the standards of efficiency. It is, in fact, in the tension between the claims of efficiency and those of justice that much of the division between conservative and liberal points of view is to be found