Utopian capitalism
Inst. of the cap econ (8 lecs)
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Utopian capitalism: two thms (6)
Exchange: contracts & power (7)
Wages & work (8)
Wages & work (continued, with
applications)
Credit markets and wealth
constraints (9)
Wealth inequality, economic
democracy and asset based
redistribution
Class and power in competitive
equilibrium (10)
Mystery lecture (no readings)
Evolutionary dynamics (5 lecs)
• Institutional innovation (agent
based models) (chapter11,
excluding 372-81)
• Collective action & institutional innovation (12)
• The co-evolution of
preferences and social
structure (13)
• Mystery lecture (no readings)
• Presentations
Research papers to be presented
• Brown, Martin, Armin Falk, and Ernst Fehr. 2004. "Relational Contracts and the
Nature of Market Interactions." Econometrica.
• Krueger, A. & Mas, A. Strikes, Scabs, and Tread Separation: Labor Strife and the
Production of Defective Bridgestone/Firestone Tires. Journal of Political
Economy 112, 253-289 (2004).
• Heckman, James and Y. Rubinstein. 2001. "The importance of noncognitive
skills:lessons from the GED testing progam." American Economic Review
• Gross, David and Nicholas Souleles. 2002. "Do Liquidity Constraints and Interest
Rates Matter for Consumer Behavior? Evidence From Credit Card Data."
Quarterly Journal of Economics, 117:1, pp. 149-85
• Banerjee, Abhijit and Esther Duflo. 2002. "Do firms want to borrow more?
Testing credit constraints using a directed lending program." MIT.
• Banerjee, A ,.M Gertler, and M Ghatak. 2002. "Empowerment and Efficiency:
Tenancy Reform in West Bengal." Journal of Political Economy, pp. 239-80.
• Craig, Ben and John Pencavel. 1992. "The Behavior of Worker Cooperatives: The
Plywood Companies of the Pacific Northwest." American Economic Review,
82:5, pp. 1083-105.
• Axtell, Robert L., Joshua M. Epstein, and H. Peyton Young. 2001. "The
Emergence of Classes in a Multi Agent Bargaining Model," in Social Dynamics.
Steven Durlauf and H. Peyton Young eds. pp. 191-211.
A surprising claim: P-efficiency as an emergent property of
decentralized interactions among self-interested agents
• The problem: allocate two goods to two individuals
x + X = 1 y + Y = 1 u = u(x, y) U = U(X, Y)
• The allocation must be P-efficient so let lower maximize
u = u(x,y) subject to U(1-x,1-y) $ U
• ..giving the familiar foc ux/uy = Ux/Uy
• NB: lower (or a planner) needs to know upper’s U function
(but upper has no motive to reveal this truthfully).
• The FT shows that under appropriate conditions maximizing
u and U s.t. their budget constraints achieves the same
result: ux/uy = px/py = Ux/Uy
• Key idea: knowledge of prices is sufficient (Hayek, 1945)
• Arrow & Hahn: ‘it is important to know not only whether it
is true but whether it could be true’
FT
• What is FT.1?
• If M, then every CE
is P-efficient
• What is FT.2?
• Im M and C then
any P-efficient
allocation can be
supported as a
competitive
equilibrium for
some assignment of
initial endowments
Ft.2: if M and C,
then any feasible Pefficient allocation is
supportable as a CE
for some initial
endowment
Why does it matter that it is true?
• Arrow: ‘Any complaints about [the market system’s]
operation can be reduced to complaints about the
distribution of income ...[but] the price system itself
determines the distribution of income only in the sense of
preserving the status quo.’
• Roemer: “If the exploitation of the worker seems unfair, it is
because one thinks the initial distribution of capital stock,
which gives rise to it is unfair”
• U.S.Supreme Court “it is impossible to uphold the freedom
of contract and the right of private property without …
recognizing as legitimate the.. inequalities of fortune that
are the necessary result of the exercise of those rights.”
• Sen: FT.2 ‘belongs to the revolutionists’ handbook.’
Limitations of the FT?
• The Walrasian exchange process is not decentralized: the
auctioneer’s prohibition of out-of-equilibrium trading at
heterogeneous prices is an essential fiction.
• Because the excess demand functions are essentially
unrestricted it cannot be shown that from an arbitrary
initial endowment the economy converges to some
equilibrium (no quasi global stability)
• Because (barring implausible conditions) the equilibrium
is not unique, knowledge of preferences, endowments
and technologies is insufficient to determine outcomes.
• Market completeness is empirically false and logically
impossible, and even small violations of M dramatically
limit the applicability of the FT to policy (2nd best thm)
Coase to the rescue!
• Coase ‘Theorem’?
• Coase replaced the Walrasian
auctioneer with a simple hill
climbing algorithm: exhaust all
mutually beneficial bargains.
• Coase: “What I showed… was
that in a regime of zero
transactions costs… negotiations
between the parties would lead
to those arrangements being
made which would maximize
wealth, and this irrespective of
the initial assignment of rights.”
The problem:
Deadheads (Bs)
vs nerds (As)
2$
(b-x)
2"
(x-a)
y+
y-
a
x*
x+
b
• The ‘initial assignment of rights’ takes the form of a curfew.
• Preferences: u = y - "(a-x)2 v = -y -$(b-x)2 and
"+$=1
• A planner: max W = u+v giving the foc 2"(x-a) = 2$(bx) Explain the foc, please.
• And the associated optimal curfew: x* = "a + $b
• Can private (Coaean) bargaining do as well?
• B pays A an amount y to secure A’s agreement to a later
curfew or receives y from A in return for an earlier curfew
How it works: suppose the initial assignment of the right is to B, then A
may pay B an amount y to secure B’s agreement to a earlier curfew.
•
Slope of A’s
indifference loci:
ux/uy = 2"(xa)
Slope of B’s
indifference
loci = 2$(b-x)
Coasean bargaining
• From the initial curfew,
b, A and B can bargain
to any point along z’rt
on the efficient contract
locus, which is identical
to the bargaining
frontier (lower figure)
• The resulting y depends
on the institutional
details of the bargaining
framework, but x = x*
Limitations of the Coase theorem?
• With conventional preferences (e.g. diminishing
MU of Y) or wealth constraints P-efficiency but
not social efficiency is achieved.
• The fact that bargaining costs are never zero is not
a limitation of the ‘theorem’ but it does restrict the
range of application of many interpretations of it.
Too good to be true? Let preferences be concave in income..
• u = u(y + y)- "(a-x)2
v = v(Y - y) -$(b-x)2
• Ecl is now given by 2"(x-a)/u' = 2$(b-x)/v‘
P-efficiency
but not s-efficiency
• With more general utility
fncts the resulting bargain
(y,x) is P-efficient but not
socially efficient.
• Basic insight: initial
assignments of property
rights will preclude social
efficiency if the social
optimum is not in the
bargaining set (because
the outcome of private
bargaining must be
mutually beneficial)
If A’s wealth is limited to y ~
Payment
from B
to A
ecl
u+
u
a
u*
x*
v*
b
q
z
y~
s
v
r
y
u
t
u
• The bargaining set is then
truncated to bqs and the
result of the bargain is Pefficient, but not socially
efficient.
z
uz
r
q
uq
u
b
v
s
t
vs
vt
v
Interpretation
• Buchanan and Tullock: ‘If the costs of organizing decisions should
be zero, all externalities would be eliminated by voluntary private
behavior regardless of the initial structure of property rights. There
would, in this case, be no rational basis for state or collective action
beyond the initial minimum delineation of the power of individual
disposition over resources.’
• Harold Demsetz: ‘it might be thought that a firm which uses slave
labor will not recognize all the costs of its activities, since it can have
its slave labor by paying subsistence wages only. This will not be
true if negotiations are permitted, for the slaves can offer to the firm
a payment for their freedom based on the expected return to them of
being free men. The cost of slavery can thus be internalized in the
calculations of the firm. The transition from serf to free man in
feudal Europe is an example of this process.’
Coase’s contribution
• A considerable generalization of FT.1 making clear
what is required (efficient bargaining, not M and the
auctioneer)
• Policy implication: remove impediments to efficient
bargaining.
• Normative implication: distinguish between efficiency
and distributive justice as objectives in addressing
market failures. (Why should the polluter pay?)
Caveats: wealth matters
• The hill climbing models do not address the fourth criticism
of the FT, namely the unreality of M and hence the problem
of market failure.
• Where M fails (in credit markets, labor markets, etc) the
distribution of endowments and initial assignment of
property titles matters for efficiency (more later on this)
Caveats: Coase Thm fails where it is most needed
• Where for reasons of asymmetric or non verifiable
information M fails (and hence the FT also fails)
efficient bargaining is also unlikely (Chapter 5).
• So the Coase Theorem is likely to be inapplicable
exactly where it is needed.
Caveats and conclusions
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•
•
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Efficiency without the auctioneer?
Markets matter
The law of the single price and stochastic exchange
Microeconomics without methodological
individualism? (Price theory without utility functions?)
• The details of market institutions matter
• Decentralized allocations that do not rely on markets?
Are efficient decentralized allocations utopian?
• Models from statistical physics (and related hill climbing
algorithms, e.g. Foley, Smale) represent truly decentralized
market-like interactions
• Foley: ‘agents enter the market knowing only the
transactions they view as improving their condition given
their endowments, preferences, technology, and
expectations; encounter other agents; and make mutually
advantageous transactions in a … random fashion.’
• For Coasean reasons, if M, the hill climbing models get to
the efficient contract locus (or approximately so) thus
vindicating the main normative thrust of FT.1, and
supplying the dynamics missing from the Walrasian models.
Caveats: markets matter
Foley: ‘Walrasian theory seeks to predict the market outcome for every
individual, while the statistical approach seeks only to characterize the
equilibrium distributions of agents over outcomes, without predicting the
fate of specific agents.’
• Because (due to out of equilibrium
trading) the stationary allocation is
not on a price plane passing through
the endowment point, it is not true in
these models that ‘the price system
itself determines the distribution of
income only in the sense of
preserving the status quo.’ (Arrow).
• Identically endowed agents end up
with very unequal outcomes.
Single price and stochastic exchange models: class and noise
• Two classes (1 worker of which h
is employed, and n ownerrs) with Cumulative income %
incomes, 0, w and r
B’
• Single price assumptions for w
and r give the line segments in the
Lorenz curve for income.
z
• Statistical and single price
A
inequality; the Gini coefficient,
(
B
C
( = (A+ B+B’)'(A+ B+B’+C)
(1-h)/(1+n)
1/(1+ n) 1.0
0
where A'(A+ B+B’+C) and
Cumulative income earners %
(B+B’)'(A+ B+B’+C) are the
‘single-price’ and ‘statistical’
contributions to the realized gini,
respectively.
Microeconomics without methodological individualism.
• The non Walrasian models of general competitive
exchange (note: not ‘equilibrium’) challenge
methodological individualism and especially the idea
that stationarity of an aggregate property (e.g. a price
vector) must be built up from the stationarity of the
individual agents.
• Gustav Cassel: take well behaved market supply and
demand functions as the primatives of economic theory
rather than seeking to derive them from individual
optimization.
• A fish story
Market demand and the individual demand function
• Source: Galliati, Giulioni, and
Kirman. See also Weisbuch,
Kirman, and Herreiner. 2000.
"Market Organization and
Trading Relationships."
Economic Journal, 110:463,
pp. 411 - 36. Data supplied by
authors.
12
quantity
10
8
6
4
2
0
0
2
4
6
8
10
12
400
500
600
price
16
daily average price
• The top figure shows the
transactions of a single
buyer in the Ancona fish
market, below is the
market demand function
for the same period.
14
14
12
10
8
6
4
2
0
0
100
200
300
daily quantity (kg)
Price theory without utility?
• ...it is sufficient for a solution to the problem of prices if we
assume that the demand for each of the commodities in question is
fixed once the prices of these commodities are given. No further
analysis of demand is needed in connection with the problem of
prices. .... The psychological processes underlying this fact have,
of course a certain interest for the economist, inasmuch as a
knowledge of them helps him to estimate the influence of prices
on demand. ...Such studies, however, lie outside the realm of
economic theory proper. 80 ...The marginal utility theory, which
in no way extends our knowledge of actual processes, is in any
case superfluous for the theory of prices. 83
• Cassel, Gustav. 1967. The Theory of Social Economy. New York:
Augustus M. Kelley [first German edition published 1923].
The details of market
institutions matter.
•Standard Ultimatum Game
•UG with competition on side of
the buyers (respondents)
•Competition on side of sellers
(proposers)
•Prices depend strongly on the
number of traders
•From Fischbacher, Uris,
Christina Fong, and Ernst Fehr.
2005. "Fairness, errors, and the
power of competition.“
•Why does fairness matter in
bargaining but not in markets?
Two ‘sellers’
Standard UG
Two ‘buyers’
Additional reading
• Hayek, Friedrich A. 1945. "The Use of Knowledge in
Society." American Economic Review, 35:4, pp. 519-30.
• Kirman, Alan. 1989. "The intrinsic limits of modern
economic theory: The emperor has no clothes." Economic
Journal, 99:395, pp. 126-39.
• Foley, Duncan. 1994. "A statistical equilibrium theory of
markets." Journal of Ecomonic Theory, 62:2, pp. 321-45.
• Axtell, Robert. 2003. "The complexity of exchange." The
Brookings Institution.
• Farmer, J. Doyne, Paolo Patelli, and Ilija Zovko. 2004.
"The predictive power of zero intelligence in financial
markets." Proceedings of the National Academy of Science.
Next time
• Read chapter 7.
• Review discussion questions for ch 7.
• Who wants to present Brown, Martin,
Armin Falk, and Ernst Fehr. 2004.
"Relational Contracts and the Nature of
Market Interactions." Econometrica