A Stitch in Haste

Consider the following simple hypothetical:

Two competent consenting adults, a seller and a buyer, meet to discuss an exchange. The seller, for reasons that are the stuff of an introductory microeconomics course, has decided that he is willing to accept any price at or above $10. The buyer, for reasons that are also the stuff of an introductory microeconomics course, has concluded that he is willing to pay any price at or below $15 for the good.

In a perfectly competitive industry, the price for the good is fixed (by the market) from the perspective of our seller and buyer. If that fixed price is between $10 and $15, then our competent consenting adults will trade at that price; any attempt by either party to obtain a more favorable price would be thwarted (by the market).

That too is introductory microeconomics, and common sense. (If the market price is above $15, then our seller will of course seek out a different buyer; if the market price is below $10, then our buyer will similarly seek out a different seller.)

If the market is not perfectly competitive, meanwhile, then our hypothetical traders would have to bargain to arrive at some price between $10 and $15 -- but what price would that be?

That is the difference between introductory microeconomics and a Nobel Prize:

The field of mechanism design theory strives to take into account the realities of economic life systematically. Adam Smith's "invisible hand" is a powerful metaphor that describes how the market, in theory, will always efficiently allocate scarce resources. Yet real-world conditions tend to complicate things. Competition is not completely free, consumers are not perfectly informed, optimizing private production and consumption may have social costs, and institutions can strongly shape economic bargaining.

The work begun by [Leonid] Hurwicz, and advanced by [Eric S.] Maskin and [Roger B.] Myerson, gave economists and policy makers new intellectual tools to address questions like those listed in the academy's citation: "How well do different such institutions, or allocation mechanisms, perform? What is the optimal mechanism to reach a certain goal, such as social welfare or private profit? Is government regulation called for, and if so, how is it best designed?"

It's been 15 years since I studied graduate level economics, and I have little to say regarding these three economists' work. I want instead to take a step back to the introductory microeconomics answer: The price will be somewhere between $10 and $15 inclusive.

Okay fine -- "something between $10 and $15." But what if we're not in the mood for Nobel-level theories and models? What is the "correct" price? What is the "proper" price"? What is the "preferable" price? What is the "moral" price? Who should "win" and who should "lose" in the negotiation process?

Trick questions all.

Go back to first principles: Both parties are better off trading at any price within the $10-15 range. If either party weren't, then he would simply go home.

The seller is better off selling at $10 than not selling at $15. The buyer is better off buying at $15 than not buying at $10. The very fact that they have traded -- freely and without any coercion, makes any and every price in the range the "correct" price from a moral perspective.

The only way to get a more refined answer than "between $10 and $15" is by changing the question. Go back to the article:

"How well do different such institutions, or allocation mechanisms, perform?"

--If the trade occurs, then they have by definition performed well. If you are unhappy about the trade, then it can only be because you care about something other than the interests of the two parties. Which catapults you outside the realm of economics altogether.

"What is the optimal mechanism to reach a certain goal, such as social welfare or private profit?"

--The goal was initially to get the trade done and in the process make both parties better off. To care about "social welfare" (defined how?) or "private profit" (to which "private" entities?) again blanks out the tautological truth that the trade was its own purpose, and to frustrate it -- or even to micromanage it -- requires the introduction of considerations apart from, and potentially at the expense, our two competent consenting adults.

Is government regulation called for, and if so, how is it best designed?

Same problem: What is the basis for presuming that a voluntary trade between two sovereign individuals could be a proper subject for government regulation in the first place?

Consider the extreme examples: If the seller is able to convince the buyer to pay $15, then you might think that the seller "exploited" the buyer. But the buyer himself, by definition, certainly does not consider himself "exploited" -- he could have refused to buy. A distaste for the $15 answer (i.e., a distaste for the seller simply because he is a seller -- a "capitalist") has no foundation in economics (or morality), but only in the subjective worldview of the anti-seller. Which, in a sane society, would certainly not entitle the seller-hater, or even a voting majority of seller-haters, from blocking the transaction (which -- never forget this -- would make the buyer worse off too).

Or perhaps you learn that the buyer negotiated the seller down to rock bottom -- $10. And then you learn that the buyer is wealthy and the seller is poor. Now who's "oppressing" whom? Again, no one -- unless you are willing to blank out the fact that the seller is by definition better off having (voluntarily) sold at a lower price than having not sold at a higher price. A subjective belief that in this case $10 is somehow a "wrong" answer makes no difference (since you are not the seller). A preference that trades should somehow be means-tested, that every buyer-seller encounter should be chaperoned to make sure than rich buyers pay $15 while poor buyers pay $10, is both anchorless and rudderless. The trade was voluntary; the parties are both better off; the bitter aftertaste in your mouth is entirely irrelevant.

("Split the difference," meanwhile, is the silliest possible answer. Why split the difference? By what criteria, other than analytical laziness, is $12.50 "superior" to either $10 or $15?)

My purpose is not to belittle this year's Nobel laureates. It is a self-apparent truth that our buyer and seller do indeed need to get beyond "something between $10 and $15." Tools for explaining -- not dictating -- the outcomes are analytically (and morally) neutral. Researching a cure for kidney disease is not the same as researching an algorithm for "optimal" government rationing of donor kidneys.

My purpose instead is to belittle those who, while presenting their own answers to the "$10-15" question, pretend that they are not doing so based on their own subjective value judgments -- those who refuse to admit that they don't really know the "optimal" solution but only feel it. The central planner wannabes who are half Paul Krugman and half Arnold Horshack. Those who, unlike these three economists, seek not to find the answer but to impose it -- sometimes even to be point where they become willing not only to dictate a price, but even to decide instead that the trade should not happen at all.

The economist asks, properly, "What price would result?" The central planner asks, improperly, "What price should result?"

Perhaps that's why there's no "Nobel Prize for Kip's Law."