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05 February 2009


WARNING: Boring Content

I just updated my post on electronic medical records. In it I had some terribly unrelated rant about the free market. I'm not sure why that was in there. I don't remember drinking while writing that, but then again I guess that would be one of the side effects. Anyways, I thought I'd expound on that rant and make sense of it. This should be a fairly boring post, but what I intend to explain is the government's responsibility to markets. Or at least my take on the governments role in the market.

First off, there are 4 general market structures. I'm going to go over them briefly, but if you really want to understand them just read their respective wiki articles.

Perfect competition: This is an economists' wet dream. The problem is that few, if any, exist. The closest examples are probably farmed commodities or eBay auctions. The characteristics that make up this market structure include: no product differentiation, producers don't set the price, and only normal profit exists. The beauty of this market structure is that the most people are satisfied with the least amount of goods. This is because equilibrium/price is found where demand meets supply.
Monopolies: Comed. Single player market, little innovation, sets own price. Fewer people get to consume the product and they pay a higher price. This results in a dead weight loss.
Oligopolists: GM, Delta. Few firms, large barriers to entry, firms set prices according to game theory (strategy based on expectations of other companies, that's why airline ticket prices are so nuts), collusion is likely because there are so few other firms in the market.
Monopolistic competition: Kraft, GAP, Crest. Like perfect competition but products are differentiated, and producers have some freedom over setting the price of their good.

So while most economists love perfect competition for its simplicity, efficiency, and fairness the reality is that it rarely if ever exists. The reality is that most markets are dominated by the other 3 market structures, 2 of which have huge barriers to entry (read: you have to have billions and political contacts) and the last which breeds advertising and brand names (Side thought: companies pay for advertising by raising the price of their product. Hence, you end up paying more for their product. Would you spend your money on billboards if given the choice? I always think about how in reality you pay for the commercials that you end up watching. It's complete insanity.). This is why economists love the idea of laissez faire/deregulation policies. In theory it works the best, but companies are run by people and sometimes people do stupid things. A perfectly competitive situation produces the most goods at the cheapest price, but the reality is that monopolistic competition dominates the marketplace - not perfectly competitive firms.

In the case of regulation, the best solution is one that stifles the market as little as possible and mitigates the business cycle (creates consistency). Here's what it all breaks down to. I think I showed why no regulation is best in theory, or at least in the right market structure (which is even funnier because the closest market to perfect competition is also one of the most heavily regulated - farming). However, in reality most markets aren't perfect and firms exist to maximize profit - not serve the greater good. Thus, markets should initially be completely free; whatever that means. The government's job is to place limits on a firms' behaviors as it becomes necessary. These restrictions will, to some extent, stunt the potential output of the economy. But they are needed to make sure that an economy can exist at all. Over time new loopholes will be exploited by companies and the government will have to enact new laws to ensure the well being of the economy.

My annoyance with all this is that people turn it into a political thing. The right screams less regulation and quotes Friedman, and the left wants regulation and quotes Keynes. It's just not that simple. Policies need to evolve over time and in step with the marketplace. I would argue that that did not happen in regard to our current mess.

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