CHAPTER 2
2.1 INTRODUCTION
A popular song maintains that money makes the world go around. This basic fact of life forms the foundation for a good deal of modern economics. Suppliers enter the market not for the benefit of the consumer but to further their own ends. In the jargon of economics, they pursue the goal of maximising their profits or return on their assets. Consumers enter the market and purchase products from firms not for the benefit of the supplier but to increase their own satisfaction. In the rubric of economics, the consumer makes decisions in order to maximise consumer surplus. Neither party has the interests of the other in mind nor the interests of the members of the society as a whole. They are interested in pursuing only their own narrowly defined ends. Like Marie Antoinette, each person's interest lies only in how much of the cake they get and not at all in the portions received by other individuals or the overall size of the cake. It is the distributional struggle that is the basic feature of economic life, not the pursuit of the efficient utilisation of resources.
One might be inclined to argue that this distributional struggle of individual ends is the underlying cause of all or most of our current economic problems. The total disregard of all other individuals is the root, so it seems, of our current economic problems. If bankers were only more publicly spirited and less interested in the pursuit of building financial empires, then fewer individuals would have suffered financial losses in both the mortgage market and the savings market. If only public officials were more virtuous and less interested in pursuing their own greedy ends, then Australia would be a better and less corrupt society. And if the wharfies were only less interested in pursuing their own conditions of employment and more concerned with getting goods from one port to another at a low cost, then this would represent one large step forward for the once "lucky country". If we could only adopt some of the work ethic of the Japanese or the Germans, then we would turn the economy around and once again achieve riches. One need only watch the evening commentaries on the news to add to this litany of complaints about just what is wrong in Australia.
The purpose of this chapter is to show that this argument is flawed. It is not Australians who must change. They need not necessarily abandon their selfish money grubbing ways. It will be shown that the distributional struggle can lead to gains for all. At a risk of giving away one of the central plots of the book, it is our argument that it is the institutions that are at fault. Our institutions have to be changed in order to channel selfish behaviour in ways that lead to benefits for all. Selfish greedy behaviour is not necessarily at fault. The propositions advanced represent some of the most fundamental principles of economics and as indicated constitute the backdrop to some of the main arguments of the book. It is therefore worth spelling out the intersection between the selfish individual distributional struggle and the good life for all.
2.2 A SIMPLE PARABLE OF MONEY GRUBBING DISTRIBUTION
Consider a simple economy of six people. It is not Australia or any other economy of which we know. It serves merely as a vehicle for the economic parable to follow. The parable serves the secondary purpose of introducing some of the basic tools of economics. The notions employed here are addressed time and time again throughout the entire work.
Each person is endowed with various commodities and money but let us focus on, say, the humble egg. Let us further suppose, quite innocuously, that each individual knows how much that egg is worth to himself or herself. Each person has specialised knowledge about what uses the eggs may serve. Harpo has discovered, or at least he believes it is the case, that if he smears whisked egg over his face then there will be an improvement in his complexion -- an important complement to his impish smile. He feels that one egg is worth $13 to him and he would be willing to pay up to $7 for a second egg. As for Groucho, he has discovered that if you crush the egg-shell this can be used to decorate a cardboard box. He would be willing to pay up to $11 for one egg and $9 for a second egg. He would be willing to part company with $20 for two eggs. On the other hand, Chico has discovered that if he mixes his egg with oil paint this helps in his production of works of art to adorn his piano. He would be willing to pay up to $8 for one egg and $5 for a second egg.
These values are depicted in Figure 2.1 in terms of descending order. By joining up the end-points of each number of eggs with a line this figure describes the demand curve for eggs. The area under the demand curve reflects how much the various individuals would be willing to pay to obtain the six eggs. In this particular example the three brothers would be willing to pay up to $53 to obtain six eggs. This implies that if they could obtain the eggs free of charge and without cost then they would be better off to the tune of $53. In terms of the language of economics, this amount represents the individuals' consumer surplus. Geometrically, it is depicted as the area under the demand curve but above the price, representing the difference between what they would be willing to pay and what they have to pay for the goods in question.
It is worth noting that the individuals derive some consumer surplus even when they are required to pay for the eggs. Suppose the price is $9 per egg. Harpo will decide that he is willing to purchase one egg but not the second. He only values the second egg as being worth $7 which is, of course, less than what he is required to give up to purchase the second egg. His consumer surplus on the first egg is $4.
Groucho is willing to purchase two eggs. He values the first egg more than what he is required to pay and would gain $2 of consumer surplus. As for the second egg, it is clear that he values it at an amount just equal to what he has to pay. In the language of economics, he is said to be indifferent between purchasing and not purchasing the second egg. It is customary in economics for the individual, despite being indifferent, to go ahead with the purchase of the item in question. On the other hand, Chico is not prepared to buy any eggs. He does not value even one of the eggs as much as the price he is required to pay. The consumer surplus when the price is $9 is the sum of the individual net gains from consumption, here $6 (equals $4 plus $2).
The numbers here illustrate an important principle of economics. When the price of a good falls, individuals will tend to increase their consumption of a commodity and this leads to a gain in benefits. If the price is reduced from $9 to zero, for example, then the potential gain to consumers will be $47; consumer surplus rises from $6 to $53.
Up to this point in the story nothing has been said about who is supplying the eggs. It is certainly true in life that there ain't no such thing as a free lunch and this will hold in our parable as well. It turns out that three individuals who go by the names of Larry, Curly and Moe, had stumbled on six eggs in a field -- mind you, without breaking them -- and each has a cache of 2 eggs. They have hit upon the idea that they can make some money by selling the eggs on the market. But each is reluctant to part company with his eggs unless he receives adequate remuneration. Each would sooner eat the eggs himself than give them away for nothing. Despite all this, Larry does not particularly like to eat more than one egg per period. He feels that the first egg is worth $12. He would be willing to give up the egg in return for any amount over $12. And as for the second, he would be willing to sell it for $2. Curly would be willing to sell his first egg for $10 and the second for $9.50. On the other hand, Moe would be willing to sell his first egg for $9 and his second for $3. These values are depicted in Figure 2.2 in ascending order. By joining up the end-points of each number of eggs with a line this figure describes the supply curve for eggs. The area under the supply curve reflects how much the various individuals would be just willing to accept to surrender their hold over the eggs.
The reader should not be alarmed by these prices. Remember this parable does not represent modern Australia, or at least not just yet. It is worth emphasising what these figures represent. Larry would be willing to part company with one egg from his find for $12. If he received any amount more, say $13, then he would be glad to conclude the deal and count on his producer surplus of $1. The term producer surplus is economic jargon for the net benefits experienced by sellers. It is also sometimes referred to as economic rent. (1) It represents the difference between what a seller receives and what he forgoes as a result of the activity. (2) In terms of the simple example here, if Larry sold the first egg, then he would be giving up the possibility to consume that egg himself which he values at $12 in return for $13, leaving him with a surplus of $1. The numbers here illustrate another important principle of economics. When the price of a good rises individuals will tend to increase their supply of a commodity and this leads to a gain in benefits. If the price is increased from zero to $9, for example, then the potential suppliers will experience an increase in benefits of $13.
In general terms and in the context of a production economy, the fact that the factors of production have alternative uses elsewhere in the economy is reflected in the positively sloping supply curve. The individuals give up time and effort in other activities if they set out to find their cache of eggs. The differing costs reflect differences among the individuals in their taste for leisure, their estimate of the likelihood of discovery and their earning opportunities in alternative activities.
Now suppose that a market-clearing or equilibrium price is established. Since both graphs have precisely the same dimensions, it is standard practice in economics to place the supply and demand curves in one diagram, as could be achieved by superimposing Figures 2.1 and 2.2. The point of intersection of the two curves represents the equilibrium in the market. In terms of the egg market the supply and demand curves intersect at a price of $9 and a quantity of three eggs. At such a price the amount being supplied to the market is equal to the amount that consumers wish to purchase. As a result there is neither a surplus nor a shortage of eggs on the market. In terms of our simple market, the equilibrium or market-clearing price is $9 per egg. Harpo would like to purchase one egg and Groucho would choose to consume two eggs. The total amount of planned purchases is three eggs per time period. At this price Larry would be willing to sell one of his eggs and Moe would be willing to sell both of his eggs.
2.3 THE FRUITS OF THE MONEY GRUBBING DISTRIBUTIONAL STRUGGLE
One particularly interesting and important result of this market process is that the equilibrium price results in the largest total gain in consumer and producer surplus. Larry gains $7 and Moe $6 in producer surplus; a total producer surplus of $13. Harpo gains $4 and Groucho $2 in consumer surplus; a total consumer surplus of $6. The total gain, or what is sometimes called the social surplus, from the market is $19. In economics the situation we have described refers to an efficient allocation. In simple terms, efficient resource allocation refers to the case in which resources flow to the highest value user.
In order to make a stark contrast, suppose the market is replaced by a planning authority which seeks to provide a fair distribution of eggs. The planner takes the viewpoint that the holders of eggs should share their bounty with the other individuals. In his attempt the planner confiscates one egg each from Larry, Moe and Curly and provides one egg each to Harpo, Groucho and Chico. The three brothers gain from this redistribution of eggs; as they had been willing to pay for the eggs that they now gain free of charge. Harpo gains $13, Groucho $11 and Chico $8 in terms of consumer surplus. The gain to the three brothers is $32. The redistribution, however, imposes a loss on Larry, Moe and Curly. They have been forced to give up one of their eggs without any compensation in return. Larry's loss (3) is $2, Moe's loss is $3 and Curly loses $9.50. The total loss is $14.50. From the standpoint of the group, the redistribution has resulted in a social surplus of $17.50 (the gain of $32 to Harpo, Groucho and Chico minus the loss of $14.50 imposed on Larry, Curly and Moe). A simple comparison of the social surplus under the two arrangements reveals that the redistribution by the planner is inferior to the distribution resulting from the interplay of market forces: $17.50 is less than $19.
It might be objected that the case here against the planned solution is biased in the sense that the three individuals have their eggs confiscated without any compensation. One might suspect that the case in favour of the market depends on the fact that the planner compels the individuals to give up the eggs without any compensation and that the case for the market would not hold if the three individuals were paid the equilibrium price of $9. Suppose the planner obtains the required revenue for compensation by levying a compulsory charge of $9 on each person who receives an egg. Under this arrangement, two of the three suppliers, Larry and Moe, would be as well off as they would be under the market -- Larry would gain $7 and Moe $6. Curly would remain worse off under this arrangement. He would receive $9 in return for giving up an egg that he values as being worth $9.50. The total producer surplus is therefore $12.50 ($7 plus $6 to Larry and Moe minus the $0.50 loss to Curly). On the consumer side of the market, two of the individuals, Harpo and Groucho, would gain the same (4) amount under the planning arrangement as they would have achieved under the market, $4 and $2. Chico on the other hand is worse off as he now has to pay $9 for the egg he only values as being worth $8. From the standpoint of the three brothers the consumers' surplus is equal to $5 ($4 + $2 - $1). The social surplus under the planning arrangement is still less than the social surplus generated under the market: $17.50 is less than $19.
The general and important lesson to be drawn from the examples given here is that the selfish distributional struggle in the market place leads to the largest possible social surplus; the wealth of the nation is at its largest amount given the available resources. It is worth emphasising the central elements of this conclusion. Each individual entered the market in pursuit of maximising his own self-interest. The eggs were supplied to those individuals who were prepared to pay the going market price, not as a result of the benevolence of the supplier. Larry, for example, was only interested in supplying one of his eggs to the market because this made him better off. He cared not in the least why one of the Marx Brothers was interested in acquiring the eggs. The indifference to the lot of the other participants in the market was true also of the consumers. They gave not even a second thought to whether the exchange made the supplier better off. Their sole area of concern in determining whether they were prepared to pay the going market rate was with whether or not this improved their own lot. Harpo, for example paid the going market rate because this increased his net benefits by $4. And yet despite the indifference to their fellow man in this individual distribution struggle, the market both improved and led to the full exploitation of the potential gains of all participants. (5)
It might be objected that the conclusion about the wealth of the nation is an artefact of the numbers used in the particular example. It is not hard to observe, however, that the market process results in the largest possible social surplus. Any outcome other than the market equilibrium will result in either a smaller quantity of goods being traded or some individuals "acceding to" trades that they would not agree to if they were free to fully negotiate the terms of the deal.
If the planner's interference leads to a smaller quantity being traded on the market, then the area of producer and consumer surplus must be smaller, as the individuals will forgo some surplus on the forsaken opportunity to trade. If the planner merely sets the price at say $12 an egg in the declared interests of supporting the industry, then the amount of eggs traded on the market will not be three but one egg per time period. Although each of the Three Stooges would be willing to supply 2 eggs to the market, only one of the Marx Brothers would be interested in paying the set price. On the supply side, if Larry turns out to be the sole vendor, then he will gain $3 (the new set price, $12, minus the market equilibrium price, $9) in additional producer surplus, but Moe will miss out on the benefits of exchange that would have occurred under the market ($6 lost in producer surplus). On the demand side, Harpo will forgo $2 of the consumer surplus he would have gained under the market and Groucho will forgo all of the consumer surplus he would have gained as a result of buying 2 eggs ($2). The loss in social surplus resulting from the planner's interference is $10 ($6 plus $4). The planner's intention of supporting the industry has instead dissipated, or perhaps more emotively, squandered a good part of the potential wealth of the nation.
Even if the planner's meddlesome ways result fortuitously in the market clearing quantity, there is no guarantee that there will be no dissipation of the social surplus. The planner, as demonstrated towards the beginning of this section, may take from those individuals who are the most reluctant of suppliers and give to those who are the least willing to pay for the planner's largesse. In the process, the potential social surplus is squandered.
It is important to understand why the market succeeds in exhausting the potential gains from trade, while the planner, even with the best of intentions, will not succeed in achieving the same level of fruits, except perhaps by some freak of circumstance. The inestimable advantage of the market process lies in the fact that market prices convey more information about the valuation of goods and services by each participant than any single individual could possess, let alone comprehend. (6) The reason why the planner in our example failed to allocate the eggs to those who had the greatest willingness to pay is that he does not know that Harpo placed a relatively high value on the egg required for his facial emulsion, that Groucho used crushed egg shells for decoration and was willing to pay as much as Harpo to have two eggs, or that Chico was interested in tempera paint and was willing to pay considerably less than the other two individuals for even one egg. By allocating each individual one egg he fails to acknowledge, as he must, the individual differences in what these eggs would be used for and how much each individual would be willing to pay in order to achieve their individual goals. The planner does not know of the painters, decorators and cosmeticians who are willing to pay for the limited number of eggs. In the case of the market process, the fact that individuals are willing to pay the market price solves the problem of deciding who places sufficient value on the good at hand without the need to know anything about the different objectives of the individuals in the economy. The market price divides the individuals into two classes; one comprises the individuals who value the commodity at least as much as the going market price, while the other consists of those individuals who do not. In doing so, the market price tells us something about the market for that good -- the identity of those individuals who have been willing to pay the cost of providing the good.
The market price can also provide an up-to-date synthesis of the information advances made by individual agents that no single individual, equipped with even the mightiest of computers, could oversee, let alone absorb. A slight modification of the parable provides one direct way of seeing the point at hand. Imagine that Harpo has discovered quite by accident -- he had observed the greedy mutt consume his "facial lotion" one week prior to the agricultural show -- that raw eggs enhance the sheen of his showdog's coat. So impressed is he with this newly found knowledge that he is willing to pay as much as $20 per egg to corner the entire market supply. In this setting, the total number of eggs traded on the egg market will be six eggs at a price of $20 per egg. Harpo will indeed be the sole consumer of eggs. The new higher market price reflects the modified value of eggs in the economy. The hapless planner, on the other hand, does not know of the recent discovery and continues to transfer one egg each to the three brothers scarcely aware that egg distribution as well as the total provision of eggs are inefficient under his regime. The new opportunities so readily exploited under the market remain totally unexploited under the dead hand of the planner. (7)
It is worth pointing out that the static or timeless nature of the parable analysed here does not offer any insight into the important concept of quasi-rent. Quasi-rents are of critical importance in the allocation of resources in any economy, although economists have often belittled their importance by focussing their attention on static equilibrium outcomes. In recent years, economists belonging to the so-called "Austrian school", especially Kirzner (1973, 1979), have argued that the notion of static equilibrium misses the importance of quasi-rents in the whole issue of resource allocation. The important lessons associated with the parable therefore need to be supplemented with a word or two about the role of quasi-rents.
2.4 THE ROLE OF QUASI-RENTS
Quasi-rent is a return to some durable asset over and above opportunity cost. Unlike the case of rent, where the supply of the factor is permanently fixed, the notion of quasi-rent attempts to capture the fact that while the resource is momentarily fixed in supply it will change in response to higher rewards over time.
Kirzner paints the following picture of the market process. At any particular point in time, existing quasi-rent provides a signal to "alert entrepreneurs" that there is scope to earn an above-normal return. In the pursuit of these higher returns, the supply of the asset (or the output obtained from it) is expanded. As a result, given market demand, the price of the asset or output will fall over time, thus reducing, or at the extreme eliminating, the quasi-rents. In an uncertain world, some entrepreneurs will make mistakes and suffer losses as a consequence. This may be caused by several things: the perception of the return may have been too optimistic, or the fall in price due to supply expansion may have been much larger than anticipated. Entrepreneurs that are making "too many" mistakes will eventually fall by the wayside. On the other side of the spectrum, some individuals will experience continual success in the market place. It is the pursuit of these quasi-rents by individuals that performs the essential function of resource allocation in the economy.
The explicit emphasis on quasi-rents as the dynamic of the market process makes Kirzner's work more useful in interpreting the real world. The difference between the static and dynamic interpretations of the market process can be illustrated with the aid of the following joke which is well known among economists:
Two economists are walking down the footpath. The one exclaims "There is a $100 note on the footpath over there", upon which the second explains "That cannot be so, because if it were true
Although there is nothing worse than explaining a joke, what it means is that the second economist has adopted a static equilibrium perspective which does not allow him to acknowledge the existence of unexploited opportunities for gain. In the dynamic perception of the world, agents will actively search for $100 notes, some of them will find some, whereas other individuals may fail to perceive the opportunity. In the process, real time will have elapsed, and the $100 note will have been on the footpath for some time.
In the market process, assets can be augmented by individual decisions. This does not mean that the quasi-rents thus created are in any sense "artificial" or to use Schumpeter's term "contrived" (Schumpeter, 1954, page 937). In fact, quasi-rents are continually being created and eliminated in competitive markets -- no single individual has the market power required to maintain any quasi-rent for a significant period of time. The quasi-rents earned over time can be referred to as the "natural" return to the assets in question. Contrived quasi-rents occur in situations where an individual has the ability to alter market conditions and prevent the erosion of the returns to the asset. Examples of contrived quasi-rents mentioned by Schumpeter (1954, page 937) include scarcity created by collusion as well as other institutional conditions such as protective duties and pieces of labour thus legislation.
Recently there has been considerable interest in yet another aspect of quasi-rent. Alchian (1987, page 142) discusses so-called composite quasi-rents or expropriable quasi-rents. Composite quasi-rent is the difference between the rent arising from the joint operation of two or more separately owned resources and the sum of the rents these resources could obtain if operated independently. The concept can, perhaps, be illustrated with the aid of the following example based on Klein, Crawford and Alchian (1978). Suppose individual A has to obtain special printing equipment to fulfil an order placed by individual B, the only one who will make use of this equipment. B promises to pay $5000 per day for A's printing services. A is happy with this as his cost structure indicates that he will be able to make a profit. Assume that A's daily fixed costs are $4000, daily variable costs are $1000 and if he were to sell the printing press, the current salvage value would be $50. The current quasi-rent on the machine once installed is $3950, being the difference between the contracted rate ($5000) and the opportunity cost of operating the machine ($1000 plus $50). Once the decision to purchase the machine was made, the fixed costs of $4000 no longer play a role in his day-to-day decisions of whether to leave the machine idle or sell it for scrap. As a result, the fixed costs do not enter into the calculation of the daily quasi-rent. In other words, the $4000 are only relevant before the machine is purchased and the contract with B is signed.
Once the machine is installed, B can then attempt to "hold up" A by arguing that he is only prepared to pay $1051 for A's services. A would still have an incentive to provide the service as B's offer is $1 higher than the opportunity cost of operating the machine. B has managed to expropriate all but $1 of A's original quasi-rent. The expropriable quasi-rent is therefore $3949.
One might raise the objection that the example trivialises business operations and therefore raises doubts about the relevance of the whole section. Does it make sense after a contract has been drawn up that one of the parties will renege on the conditions, in this case proposing a smaller than agreed-upon payment? In a world of completely specified (and costlessly enforced) contracts, this would indeed be a valid objection. In practice, however, contracts can at best be only incompletely specified owing to the inherent uncertainty created by time. It is B's ability to exploit the terms of the contract that allows him to propose a lower payment.
The relevance of the concept of expropriable quasi-rents lies in the fact that it allows us to investigate the economic rationale behind observed business practices and institutional forms. Returning to the example, one way for A to reduce B's ability to act opportunistically post-contract is for A to demand a performance bond to be forfeited upon misconduct by B. Alternatively, A and B can vertically integrate to operate as one firm.
There is nothing in the logic of the analysis preventing A from trying to act opportunistically towards B. Suppose, for example, that B has no other immediate supplier of the required printing services. It may then be possible for A to "hold up" B. But B's response to this could be to install or hold standby facilities which could perform the task. Regardless of the direction of the opportunistic behaviour, real resources are being devoted in order to maintain the terms of the contract and the expected quasi-rents.
2.5 A QUESTION OF TRUST
There is, of course, a real danger in characterising all economic exchange as a continual process of "cheat and be cheated" on the part of all agents. Basu (1983) tackles this issue in a particularly illuminating fashion when he asks why we don't walk off without paying after a taxi-ride. Consider the case of an individual late at night in Sydney. The street is deserted. If there is nobody on the street when he is getting out, then clearly economic rationality would seem to suggest that he run off and not pay (provided the taxi driver looks less fit than him or is incapacitated in some way). (8) Or, alternatively, economic precepts might suggest that the taxi driver expropriates the passenger's wallet of its entire content. All this certainly follows from the perspective espoused by Klein et al. (1978), where each and every individual is out to exploit every opportunity for personal gain. A moment's thought about everyday life reveals that there must be something else accounting for the absence of extreme opportunism. Basu (1983) suggests that agents adhere to norms and morals, even at the expense of their pecuniary interests. We tend to pay for the taxi-ride because we think it is right to fulfil one's obligations. The point we are trying to convey is that the successful operation of the market system will depend on unwritten moral rules as well as the more familiar and obvious explicit legal dimension of the parable. (9)
ENDNOTES
1. The concept of economic rent is one of the oldest concepts in economic science. The Classical economists defined rent simply as payments to the owners of land. The concept of economic rent was extended by Alfred Marshall. He defines rent as "income derived from the free gifts of nature" (Marshall, 1920, page 62). In that sense, the scarcity of the resource is considered to be a given state of nature, not subject to manipulation by any individual economic agent. The modern interpretation of economic rent is even more general. A factor of production is said to earn economic rent if its payments are above what would have induced it to its employment.
2. It is possible for the situation to be such that the market for a factor of production is as indicated in Figure 2.3. The supply curve (S) for the factor is vertical, which indicates that there are no alternative uses for this factor elsewhere in the economy. So, regardless of the payment to the factor, the quantity offered for sale in the market place is always equal to Q*.
Suppose that in equilibrium in the market for this factor, the payment to the factor will be at the level where demand equals supply, that is, at P*. Now it is clear that the suppliers of the factor in question are earning economic rent. Indeed, the supply of the factor is equal ta Q* even if the factor is paid a zero amount. Hence, the entire amount paid to the factor, equal to area OQ*AP* in Figure 2.3, constitutes economic rent.
3. A question might be raised here. Why does confiscation result in a loss equal to the value placed on the second, as opposed to the first, unit held by each individual? In answering this query, it ought to be borne in mind that the eggs are identical to each other in all respects. One egg could be interchanged with the other egg without affecting in anyway the individual's evaluation of the two eggs. It is simply not possible to identify the value of any particular egg. So when an egg is confiscated, the individual loses the value he had placed on the last egg, or what economists call the marginal egg. Larry had been willing to pay up to $14 to consume two eggs. If asked how much he would be willing to pay to consume one egg, he would reply $12, the value on his first unit of consumption. The confiscation of one egg results, therefore, in a loss of $2 -- the difference between his willingness to pay for one and two
4. It might be argued that Groucho can not be as well off under the planning arrangement as he only gets to consume one rather than two eggs. It is true that under the market arrangement he secures more eggs. But he also pays for each additional egg. In the case of the market he pays $9 for each egg but only values that second egg as being worth $9 to him, leaving a consumer surplus only on the first egg.
5. It is worth noticing that some economists argue that it is inadmissible to sum the consumer and producer surpluses across the individuals concerned and that the measure of social surplus is of little interest to the analyst in assessing the performance of some institutional arrangement. Instead, the outcome that follows from the interaction between individuals within some institutional context ought to be assessed by asking whether or not each individual is no worse off as a result of the process. If some individuals are better off and no other individual is worse off, then the change is regarded as desirable. In the case of the market process each and every individual is made better off by trading. This of course follows from the simple observation that individuals would not voluntarily surrender their property right over a commodity unless this made them better off. In this particular case the two ways of assessing performance lead to the same end. The market exhausts all the potential gains from trade, which is to say that it improves and fully exploits the lot of all the participants. For the sake of simplicity, the performance of the various institutional arrangements discussed in this work will be made with respect to the size of the total social surplus.
6. The informational advantage held by the use of the market process was forcefully expounded by Hayek (1945).
7. In all the examples in this section we have implicitly assumed that the eggs cannot be re-sold.
then someone would have already picked it up".
8. It is worth noting that the scenario has been set up in such a way that the individual can draw the conclusion that he is not at risk of any penalty if he runs off into the night without paying. The individual's decision to pay the taxi driver cannot be explained, therefore, by making an appeal to the expected penalty of the law. In fact, for this type of individual -- those who do not opportunistically exploit every situation to their own advantage -- the law does not influence their own behaviour. The possibility of altering the opportunist's behaviour by the law is examined in a subsequent chapter.
9. This phenomenon has been extensively studied by other social scientists as well as moral philosophers. See, for example, Elster (1989), Coleman (1987, 1990), and Parfit (1984).
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