Bryan Caplan  

Tabarrok Corrects Rodrik (and a Lot of Textbooks)

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Today Alex makes a point that I drill into my graduate students: The assumptions underlying the standard market efficiency theorems are sufficient conditions for market efficiency, not necessary ones. Dani Rodrik and the many econ textbooks that claim that market efficiency requires perfect competition, perfect information, no externalities, etc., are simply wrong.

The real story: Given these admittedly restrictive assumptions, market efficiency is guaranteed; if one of those assumptions are violated, market efficiency remains possible.

Yes, that means that markets with small numbers of firms, imperfect information, and externalities can work as well as markets with lots of firms, perfect information, and no externalities.

Examples abound: Bertrand oligopoly - and even contestable monopoly - show that industries with a small number of firms - or even one firm - can be efficient. A monopoly in an industries with negative externalities can be efficient. Large but infra-marginal externalities are consistent with efficiency. And don't get me started on imperfect information.

Despite my best efforts, I've succumbed to anti-foreign bias in the past. When I read textbook treatments of market failure, I fear that my fellow economists have yet to free themselves from anti-market bias.

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COMMENTS (3 to date)

This is a classic problem - human beings expect every rational statement to be commutative.

So when you say:

"Given these conditions, you must have market efficiency."

These people infer:

"Given market efficiency, you must have these conditions."

I am not sure how to efficiently combat this. Some people simply don't understand the difference between these two statements. They simply can't identify the pattern as a case of "Jack eats pie" and "pie eats Jack", which is clearly incorrect.

I have often pondered whether this phenomenon, which may be described as a tendency to confuse subject and object, is related to the human tendency to confuse subjectivity and objectivity.

PrestoPUndit writes:

Of course, when economists use the words "market" and "effeciency" here they are trading in puns -- words only distantly related to the real world meaning of these words. In other words, as used by economists these words are part of a math jargon having reference to imaginary conceputal objects within a math model. Economists typically fail to successfully link their jargon to the empirical worlds we all know at the market, no scare quotes required.

The deepest "bias" of the economists is against leaving the fantasy playgrounding of mathematics -- i.e. economists have a deep bias against providing sound and coherent causal explanations of real world phenomena.

R. Richard Schweitzer writes:

Other than Coase, in his particular approach (cost/value), does anyone try to deal with the differences in perception of information, as opposed to commonality of perceptions that would make the same information have the same meaning to everyone participating?

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