Ronald Coase on monopoly as the default explanation for perplexing business practices
11 Dec 2014 Leave a comment
Why does government fail?
31 Aug 2014 Leave a comment
in applied price theory, applied welfare economics, comparative institutional analysis, Ronald Coase Tags: comparative institutional analysis, government failure, market failure, Ronald Coase
Advertising and free speech: the best test of truth is the power of the thought to get itself accepted in the competition of the market
08 Aug 2014 Leave a comment
Coase, Boulding and Marshall on mathematical economics
02 Jul 2014 Leave a comment
in Ronald Coase Tags: Alfred Marshall, Kenneth Boulding, mathematical economics, methodology of economics
Can anyone think of a mathematical economics proposition that was accepted that was not consistent with what Kenneth Boulding called the literary vagueness of classical economics and economic sociology:
Conventions of generality and mathematical elegance may be just as much barriers to the attainment and diffusion of knowledge as may contentment with particularity and literary vagueness…
It may well be that the slovenly and literary borderland between economics and sociology will be the most fruitful building ground during the years to come and that mathematical economics will remain too flawless in its perfection to be very fruitful.
If mathematical economics came up with a result that was not reproducible through economic intuition, did the result become popular or were they ignored? Until this barrier is passed, mathematics will be a shorthand language rather than an engine of enquiry, as Alfred Marshall argued long ago:
[I had] a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules –
(1) Use mathematics as a shorthand language, rather than an engine of inquiry.
(2) Keep to them till you have done.
(3) Translate into English.
(4) Then illustrate by examples that are important in real life.
(5) Burn the mathematics.
(6) If you can’t succeed in (4), burn (3). This last I did often.
Marshall also
saw that excessive reliance on this instrument [mathematics] might lead us astray in pursuit of intellectual toys, imaginary problems not conforming to the conditions of real life.
Information costs are just costs?
25 Jun 2014 Leave a comment
in applied price theory, comparative institutional analysis, Ronald Coase Tags: Armen Alchian, Harold Demsetz, Yoram Barzel
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Yoram Barzel and Harold Demsetz pointed out that some economists want to stigmatise information costs. Armen Alchian was in this camp too.
Demsetz asked why the costs of finding, digging up and processing an ore deposit is a legitimate cost, but the costs of finding and interpreting information are illegitimate costs. There is an arbitrary classification of costs going on here according to Demsetz:
…there exists an efficient amount of ignorance in an economic system if the cost of acquiring information is positive.
The amount of ignorance that is efficient increases as does the cost of transacting (viewed as the cost of conveying information). Ignorance not only may be bliss, it also may be efficient.
One cannot claim that resources are wrongly allocated simply because information is not possessed or negotiation is absent; nor can one claim that resources are misplaced because a specific market does not exist.
None of these is free, and the costs of acquiring information and creating and maintaining markets may be so high as to make it efficient to forego some information and some markets.
A decision that something is not worth taking into account is not, because of this, a source of inefficiency. That this something is not taken into account is a reckoning if it follows from a thoughtful anticipation that it is not worth taking into account. An explicit accounting for every ‘something’ would be inefficient indeed in a world in which knowledge is not free
Coase and Demsetz on comparative institutional analysis and the fallacy of comparing actual institutions with unrealistic, idealised alternatives
23 Jun 2014 Leave a comment
in comparative institutional analysis, constitutional political economy, Ronald Coase, Ronald Coase Tags: Harold Demsetz, Roanald Coase
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It is my belief that the failure of economists to reach correct conclusions about the treatment of harmful effects cannot be ascribed simply to a few slips in analysis. It stems from basic defects in the current approach to problems of welfare economics
Ronal Coase (1960)
The view that now pervades much public policy economics implicitly presents the relevant choice as between an ideal norm and an existing ‘imperfect’ institutional arrangement.
This nirvana approach differs considerably from a comparative institution approach in which the relevant choice is between alternative real institutional arrangements…
the design of institutional arrangements that provide incentives to encourage experimentation (including the development of new products, new knowledge, new reputations, and new ways of organizing activities) without overly insulating these experiments from the ultimate test
of survivalHarold Demsetz (1969)
Ronald Coase on blackboard economics
16 Jun 2014 Leave a comment
in history of economic thought, industrial organisation, law and economics, Ronald Coase Tags: blackboard economics, methodology of economics
This neglect of other aspects of the system has been made easier by another feature of modern economic theory – the growing abstraction of the analysis, which does not seem to call for a detailed knowledge of the actual economic system or, at any rate, has managed to proceed without it.
Holmstrom and Tirole, writing on The Theory of the Firm in the recently published Handbook of Industrial Organization, conclude at the end of their article of 63 pages that "the evidence/theory ratio… is currently very low in this field". Peltzman has written a scathing review of the Handbook in which he points out how much of the discussion in it is theory without any empirical basis.
What is studied is a system which lives in the minds of economists but not on earth.
I have called the result "blackboard economics". The firm and the market appear by name but they lack any substance. The firm in mainstream economic theory has often been described as a "black box". And so it is.
This is very extraordinary given that most resources in a modern economic system are employed within firms, with how these resources are used dependent on administrative decisions and not directly on the operation of a market.
Consequently, the efficiency of the economic system depends to a very considerable extent on how these organisations conduct their affairs, particularly, of course, the modern corporation.
Even more surprising, given their interest in the pricing system, is the neglect of the market or more specifically the institutional arrangements which govern the process of exchange.
As these institutional arrangements determine to a large extent what is produced, what we have is a very incomplete theory.
Four years before his Nobel lecture, Coase was more specific:
Marginal cost pricing is a policy is largely without merit.
How then can one explain the widespread support that it has enjoyed in the economics profession?
I believe it is the result of economists using an approach which I have termed “blackboard economics.”
The policy under consideration is one which is implemented on the blackboard. All the information needed is assumed to be available and the teacher plays all the parts. He fixes prices, imposes taxes, and distributes subsidies (on the blackboard) to promote the general welfare.
But there is no counterpart to the teacher within the real economic system. There is no one who is entrusted with the task that is performed on the black- board.
In the back of the teacher’s mind (and sometimes in the front of it) there is, no doubt, the thought that in the real world the government would fill the role he plays. But there is no single entity within the government which regulates economic activity in detail, carefully adjusting what is done in one place to accord with what is done elsewhere.
Coase argued that marginal cost pricing is not only inefficient, but even inferior to average cost pricing due to:
(i) the fact that under marginal cost pricing, consumers are not forced to pay the full costs of the goods they purchase, leading to potentially inefficient consumption choices;
(ii) the lack of information necessary for the government to determine whether consumers would be willing to pay an amount sufficient to cover the total cost of the goods produced, and costly nature of attempts to make such estimates; and
(iii) the fact that the governmental subsidy necessary to ensure firm survival under a marginal cost pricing scheme will likely be financed through distortionary taxes, thereby creating or exacerbating a distortion in one market at the same time that it corrects a distortion in another.
Ronald Coase and the preoccupation with monopoly
23 May 2014 Leave a comment
in industrial organisation, law and economics, Ronald Coase Tags: market process, monopoly
One important result of this preoccupation with the monopoly problem is that if an economist finds something—a business practice of one sort or other—that he does not understand, he looks for a monopoly explanation. And as in this field we are very ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on a monopoly explanation, frequent.
After this foray written in 1971, Coase went further in an appreciation written for George Stigler’s Nobel Prize in 1982:
…for reasons which are not altogether clear to me, it is a field [of industrial organisation] which has come to concentrate on The Monopoly Problem and, more specifically in the United States, on the problems thrown up by the administration of the antitrust laws.
The result has not been a happy one for economics.
By concentrating on the problem of monopoly in dealing with an economic system which is, broadly speaking, competitive, economists have had their attention misdirected and as a consequence they have left unexplained many of the salient features of our economic system or have been content with very defective explanations.
Ronald Coase on applied welfare economics versus comparative institutional analysis
21 May 2014 Leave a comment
in applied welfare economics, constitutional political economy, law and economics, Ronald Coase Tags: Coase, comparative institutional analaysis
All solutions have costs, and there is no reason to suppose that governmental regulation is called for simply because the problem is not well handled by the market or the firm.
Satisfactory views on policy can only come from a patient study of how, in practice, the market, firms and governments handle the problem of harmful effects….
It is my belief that economists, and policy-makers generally, have tended to over-estimate the advantages which come from governmental regulation.
But this belief, even if justified, does not do more than suggest that government regulation should be curtailed. It does not tell us where the boundary line should be drawn.
This, it seems to me, has to come from a detailed investigation of the actual results of handling the problem in different ways.
Utopia, you are standing in it! 
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