As Stiglitz wrote in the 80s and many others have followed, the fundamental problem of asymmetric information where the buyer or the seller knows more than the other, leads to inefficient market allocations. So saying that markets lead to efficient outcomes is a fallacy, in the real world, you never have perfect information.

Also, forget the problem of efficiency, what about the problem of equity? Economists conveniently relegate equity to the lap of social scientists, but no market interaction can be studied in equity vacuum. In this case, just ask yourself, is it fair that this guy with dementia got duped out of his money? And so, isn’t it fair that the judge awarded him extra compensation on that ground?

(Indeed, I’ve seen rationing of medicines in practice in Latur after the earthquake there. An unbelievable black market sprung up for medicines, and the people who most needed it never got it. I travelled through the affected areas in an ambulance with paramedics, and I saw it all first-hand, hospitals being emptied of medicines by black marketeers headed out of the area. Naturally, I’m not saying you should leave situations like to the market: immense charity is required at such times, and it was far more efficiently provided by private NGOs and so on than by the bumbling govt.)

Shikhil, in the case I cited it seems the buyer paid willingly, and complained later. Of course, his alleged dementia adds an extra angle to the case, and isn’t part of my comment.

Dweep, thanks for the examples cited, though it’s probably wrong of me to expand on the issue of natural monopolies (which I believe are unsustainable, and MS Office certainly is not a sustainable natural monopoly, just as Windows and IE aren’t, though they were once thought to be). Perhaps we should discuss that larger issue elsewhere.

Dweep, as I said, I don’t believe that people always act rationally. That is irrelevant, in my view, as long as they act of their own volition. As long as they do that, I don’t believe that anyone has the moral right to interfere with their decisions. This applies as much to trade as anything in a social context.

But even besides the moral aspect of it, the history of economics shows us that economic freedom and prosperity are closely related. In the context of prices, surely the damage that price controls do cannot any more be disputed.

As for your third point, we’ll have to agree to disagree, I think.

Con man, if the scenario you cited was the rule rather than a hypethetical example, then price control would reduce shortages instead of causing and increasing them. Yet, that’s never been the case, has it?

http://www.counterbias.com/705.html

what else do you expect in India?

Now to your responses:
‘An example of a permanent natural monopoly?’
- Infrastructure? Microsoft Office? Not sure what you imply by permanent?

‘Two, I don’t believe that all decisions in a marketplace are rational, nor do I think that this belief “underlies free market theory” as you put it. And it has little to do in the real-world examples I cited, for example.’
- Rationality ‘underlies free market theory’ in so far as to justify the market price as the ‘correct price’. Because it presumes that the market price was arrived at by people acting in their rational self-interest. If people can agree on a ‘wrong’ price, then we can no longer equate the market price with the best price.

‘Three, by the market, I mean the people who constitute it. I use the two synonymously and interchangably, and I don’t see why, barring intervention, there could be a difference.’
- Precisely my point. Economics is wrong to assume that a market driven by cold, calculated math is the same as people that are anything but. In my view, the market you speak of is not the people that constitute it but a textbook scenario in which people are mostly willing participants. Yet, sometimes they may choose to diverge from its rules.

Perhaps I completely misunderstand the basics of economic theory.

Regulations and restrictions destroy this close balance. In other words welfare for both consumer and producer is maximised in free market in absense of regulation and interventions like taxes.

In the article the judgement on fondling was mentioned, and it was said that the woman may charge whatever amounnt suitable for her (because there is no right price and because of her willingness to supply). But here we also have to take into consideration the buyers willingness to pay. I guess the court verdict is justifiable on grounds that no one would pay thousands of dollars just to fondle breasts..

The reason I cited Katrina was this sentence in your original post

“But natural market prices are the best possible way to efficiently allocate resources at any time.”

At the time of the hurricane, the “natural price” of eviction could only be paid by the reasonably rich. Clearly, resource allocation by the market prices failed in this situation since many people paid with their lives, injuries, trauma, property damage and so on. I only wanted to point out an “extreme example” to possibly show the limits on the above statement.

I agree that no one in reality makes the assumptions I stated. My comment only addresses that economic theory of demand-supply and market prices being the “optimal” mechanism of resource allocation rests on these conditions being satisfied. Market prices are an excellent market-clearing mechanism. It is not necessarily optimal.

“Rationing” just addresses the part where you say the “early buyers” of fixed price goods may buy “excess” quantities and deprive others. By “rationing supply” and simultaneously capping prices, some allocation is possible, especially in situations such as famine. Reputational and other information mechanisms can be utilized to curb black marketing and racketeering in these circumstances. There is of course the risk of these price and quantity controls becoming permanent, after the emergency situation has gone away. That I believe is more a political than economic issue.

Sarat, sorry, I’m not competent to answer that question, as I don’t know anything about that aspect of the US economy. But it’s far from free-market heaven, that much I can tell you.

Dweep, thanks for the insightful comment. Three things: one, can you give me an example of a permanent natural monopoly?

Two, I don’t believe that all decisions in a marketplace are rational, nor do I think that thsi belief “underlies free market theory” as you put it. And it has little to do in the real-world examples I cited, for example.

Three, by the market, I mean the people who constitute it. I use the two synonymously and interchangably, and I don’t see why, barring intervention, there could be a difference.

Mihir, good points. But who assumes “perfect competition” and “rational decision making” while lauding free markets? I don’t, and don’t know of anyone silly enough to do so. Also, I don’t see what New Orleans has to do with the discussion here on prices.

Also, as I said before, I have nothing against charity in the time of a disaster. But I suspect your support for “rationing” might focus more on intent than outcome. It might be “seen to be a fair mechanism” as you put it, but more relevant than what it is “seen to be” is what it is, and what the incentives involved make it likely to be. Economics should not be based on wishful thinking.

However, I believe that it is dangerous to apply the same logic in cases of natural (or man-made) disasters. Several assumptions underlie the theoretical result of a dynamic market equilibrium (perfect competition, rational decision making..) are almost always violated in real markets, and more so in disaster situations. Numerous examples can be cited - the price of “eviction” from New Orleans was so high (ownership of cars, insurance on houses and other assets) that only the reasonably rich were able to escape Hurricane Katrina, leaving those who couldn’t afford these to face tragedy.

Also, demand-supply matching never happens instantaneously. In disaster situations, providing for basic human needs of all people suffering - clean water, food for survival, shelter - is the primary goal. In such shortage situations, including famines, “rationing” at the lower prices (or sometimes at zero prices) is seen to be a fair mechanism, equalizing all irrespective of their ability to pay. Yes, I can see that “rationing” is a word that will have many people up in arms, and is itself subject to corruption, hoarding, politicking and so on. Coupled with rights to information, and especially in situations where “social pressure” exists, it can work better than a price mechanism. (Also, in severe disaster situations, currency itself may not retain its meaning, putting in question the economic system itself).

Belief in markets and opposition to price controls in general is one thing; being blinded by these beliefs is quite another.

First, free markets are known to have failures due to natural monopolies, imperfect information, etc. Further, while you claim (correctly) that a market transaction indicates the will of those involved, there are several caveats - people’s preferences are not always obvious, nor do they necessarily act freely or in their own long-term interests. In other words the presumption of ‘rational’ behavior that underlies free market theory does not always hold.

At another level, we can even question if efficiency is what we want. What if the market outcome is not the most equitable, or what people want?

My own shallow study of economy taught me one thing - that the field conveniently ignores the normative, for the positive. This is great for resource allocation, but not for wider policy tradeoffs that are called for in life. To completely ignore ethical, moral, and normative concerns is to ignore a large part of what makes us human, and therefore perhaps ‘irrational’. I’d suggest a quick reading of Sen’s Economics & Ethics in this context.

I will support most examples you suggest as well as the bulk of your argument, but caution against a blind belief that the ‘market knows best’. Because then you put ‘the market’ above those that constitute it.