Markets

Why Free-Marketers Simply Don’t Understand People

Market rules aren’t facts of nature

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By Jag Bhalla

We’re letting unnatural “laws” mislead us. Markets aren’t like gravity; they’re ruled by neither laws of nature nor commandments carved in stone. Delegating our ethics to markets risks costly error.

1. A failed 50-fold drug price increase (Daraprim $13 to $750) is revealing. It recalls the irritation over Uber’s 700 percent snowstorm “surge pricing,” when free-market fans groaned: People just don’t understand “simple economics.”

2. I’d say some free-marketers simply don’t understand people. Or people’s ethical reactions. Despite labeling large price hikes “logical and fair” or rational and efficient, they still smack of exploitation and upset people. Economics entails ethics (forceful, systemic, global, ethics) and rightly provokes “fairness” reactions.

3. The relevant “simple economics” is the “law” of supply and demand. Roughly: Price signals ensure markets “clear” efficiently. Rising prices = greater demand = encourage more supply, and vice versa. “Clearing” means all supply is sold (not necessarily used efficiently).

4. Let’s compare two allocation schemes: An entrepreneur makes 100 widgets for $10 each. Using cost-plus pricing, she sells all for $13 each = $300 profit. Using what-the-market-can-bear price maximization she sells at $750 each = $74,000 profit. Way better for her, obviously. But overall? Is it better that 100 customers have $737 less? How they use $737 might benefit the economy more (higher economic multiplier).

5. Again, market rules aren’t facts of nature. They’re choices, which shape incentives and guide markets toward certain goals. Our rules needn’t prioritize supplier profits over other community goals. Note: Cost-plus doesn’t limit profit — to make more, satisfy more customers. Free-marketers might prefer price-gouging, but its benefits aren’t self-evident. Unless taught, market logic is “cognitively unnatural.”

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6. Plus market “mechanisms” empirically vary (whereas gravity-like laws of nature are nonnegotiable — they work the way they work no matter what we do). E.g., some markets use cost-plus pricing (= once popular within economics).

7. Before heeding the “free-markets-in-everything” crowd, remember that markets are human-made systems for allocating resources. Before letting market forces (mindlessly) coordinate countless transactions, remember how flat-out wrong economists can be (and that they use “rational” and “efficient” differently, sometimes misleadingly).

8. Besides, economics and its “laws”/claims often fail. Free markets neither logically nor empirically automatically convert self-interest to social good, nor generate “spontaneously ordered” optimal outcomes. It’s not that simple.

9. Those who love the many great things that markets do could work harder to fix related ills. Nothing compels us to let Californians water lush lawns while the poor’s wells run dry, or make musical toilets while some starve. Widgets, medicine, Uber, musical toilets, food, and water aren’t ethically equivalent, or equally auctionable. Let’s pick allocation schemes accordingly.

10. We can use the massive power of market forces to support our ethical goals. Perhaps America’s founding goal of rules “wholesome … for the public good.”

But if you’d prefer a world safe for price gouging, let’s do more “simple economics” training: market-gouging drills in kindergarten? Daily pledges “one Nation under” profit … dedicated to the idea “that government of the people, by the people,” for the profit, shall not perish from the Earth?

Published at Big Think

Illustration by Julia SuitsThe New Yorker cartoonist & author of The Extraordinary Catalog of Peculiar Inventions


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  • Swami Cat

    Jag,

    Give it a rest, dude. Your writing style is to assume a worst-case, raving lunatic, free-markets uber alles strawman and then feel good about yourself when you tear him back down to size. Bad rhetorical form.

    If we want an intelligent and worthwhile discussion on the topic of profit, may I suggest the following?

    Profit is both a reward and a signal in economics, assuming reasonably functioning market institutions (which are often other than market based). The opportunity for higher margins thus incentivizes activity. On the positive side, it incentivizes lowering costs, improving quality or improving or designing new features, products or services for consumer demand. These things do not happen spontaneously. They require investment, trial and error, and risk huge losses (the opposite to profit which again is a signal and a reward).

    When (well, actually if) a firm creates an improved solution, the market rewards them with large profits. They can price as high as reasonable considering volume, brand positioning, scale effects, etc, thus repaying (and justifying) the risks of innovation.

    However, remember, in a reasonably functioning market there are no entrance or competitive barriers. The outrageous profits thus act as a signal and incentive to competitors to enter the fray and gain these outsized returns. This attracts capital and pulls competitive supply into the market, reducing profit, eventually toward the risk adjusted cost of capital. Thus we have a free market innovation feedback loop which constantly experiments, innovates and creates new and improved products and services for the flourishing of humanity. Just about every man-made object around you is the result in part of this free market innovation process (I say in part because science and other institutions also play an important and mutually enhancing role).

    Don’t get me wrong, markets don’t work in every case. Markets require institutional support. In addition profits can also be earned via non market activities, such as rent seeking or monopolies. In which case, profits are a bad thing.

    I will also add that public opinion plays a role too. The reason firms don’t usually price 100% to what the market will bear (your examples are perfect exceptions proving the rule by their very outrageousness). is in part due to consumer backlash.

    Markets are complex adaptive systems. Profits is part of what makes the system work. And yes, children should learn this in school. You would be better at what you do if you fully groked it. You see, markets are not just a system of allocating resources. They are also a system for creating resources, and absent free roaming profits and losses in a competitive field, this creative aspect is stillborn.

    Would you like some links to books or articles which could expand your views?

    • Proof of work

      I take his point over yours. You are living in a bubble made by those books and articles. No links for me. Doing just fine in the real world. Markets don’t create resources. Nature does and people extract and fashion them for utilitarian purposes. Markets are at the other end where exploitation enters.

      • Swami

        It is would have been more accurate for me to say that markets are a decentralized system of discovering, creating, improving, and distributing solutions to human problems.

        But my guess is this would not set well with your disposition either.

  • article:published_time” content=”2015-11-15T22:21:35+00:00″

  • David Burns

    Bashing the old model does no good. https://d.gr-assets.com/quotes/1416673182p8/13119.jpg

  • Clinton Weir

    If the market will bear a $750 widget, then the entrepreneur will make a lot more money, yes. But more importantly, she and/or other entrepreneurs will notice that widgets are a profitable business and will invest in expanding production capacity to cash in.

    The second entrepreneur to address the widget market will have to make his or her widget better or cheaper, and probably both, and the consumer will benefit.

    Ultimately, whether the widget is $1 or $1,000, the consumer has the choice to buy it or not, and will only buy it if the consumer perceives the widget to be more valuable than the money they must spend to acquire it. In other words: the consumer enjoys a kind of profit (usually called a consumer surplus) every time he or she buys something.

    • What your describing is possible only in a perfectly competitive and perfectly efficient free market at equilibrium. Those don’t usually exist except maybe for the porn industry (don’t ask why, but for complex reasons porn seems to fit the economic models better than any other product). In actual practice there are so many confounding variables like information Asymetry (the consumer doesn’t know how much the widget costs from other vendors, the widget vendors keep information about how many widgets they sell yearly a secret so new companies can’t decide if it’s cost effective to build a widget making factory, etc.). Other confounding factors include the ability of the vendor to change the price at will after the widget purchaser has spent money on price shopping which is why we have laws against “bait and switch advertising” where a store will advertise a widget at a low price and then when the customer travels to the store to buy it the store is out of that widget but has one just like it that will work as well only twice the price.

      Economics theory is kind of useful as rule of thumb but very easy to misapply and misuse in an argument. The problem with economics theory is it only works in theory and in practice the assumptions for the theory to work are rarely met. for the theory of supply and demand to work efficiently the requirements include things such as perfect information, rational actors (everyone makes the best financial choice without emotion or urgency or individuality), no barriers to entry (it costs a business zero dollars to start a widget company), money has equal value to all people, etc. How far off is micro-economic supply and demand theory will depend on how close, or more frequently how far away from the requirements a market really is. In practice knowing how far away any specific market exchange deviates from the “perfect free market prediction” has more effect than the theory itself. So where theory might predict for a perfect market a price of $100 for a widget, the actual price might be as low as $5 or as high as $5000. That makes the general principle of supply and demand economics a very poor principle for understanding real world problems like what would happen if the minimum wage were raised from $8 to $15/hr.

      • Clinton Weir

        Newtonian Physics are only approximations, too. Mind you, they are really good approximations in most of our common experiences, but they completely break down in extreme scenarios (analogous to your water monopoly scenario), and those shortcomings show up in some remarkably mundane modern technologies like GPS.

        Your theory that there’s no way to know how popular a product is if the seller does not publish sales stats is comical. Where there’s a will and a profit incentive, there’s a way.

        • Newtonian physics and the theory of gravity predicts that the earth will be completely flat with a uniformly distributed layer of water 5 ft deep covering every square foot of the planet. According to the theory of gravity, people are slightly lighter than water and therefore would only be found floating near the surface and never on dry land which wouldn’t exist. Using the theory of gravity is very easy to predict the exact elevation of every person on the planet since they’ll all be floating at the surface of the water. . . .So in reality if you want to predict the elevation of a person it’s the theory of plate tectonics and realization that people don’t exactly follow the law of gravity exclusively you need to be thinking about. That’s not to say the theory of gravity is false, and in general you don’t find people in the middle of the earth or flying high in the sky very often.

          The micro-economic theory of supply and demand has the same interpretation problem as the theory of gravity. They are both completely true theories that have been proven in lots of ways lots of times. But both of them have similar obvious failings when trying to predict people. The failure is that both theories predict insufficiently all by themselves the behavior of people that have many other theories and principles than just economics and gravity. For gravity the other principles that determine the elevation of people are hard to discover but clearly it’s almost always true people are above the heavier dirt and float on water and people don’t fly up into the air. For economics supply and demand, prices are similar in that the price of a product can’t drop below the production cost or rise above the value of the product for a the richest person. Wages have to be high enough for people to survive on otherwise they die and can’t work and no one can be paid more than the sum total of all the profit made by a company. So I’m not arguing against the validity of supply and demand economics or the theory of gravity. BUT for real world purposes both the theory of gravity and the theory of supply and demand economics are insufficient.

          • Clinton Weir

            Your physics sucks as much as your economics.