Prof. Bryan Caplan

Econ 370


Week 11:  Making Fair Comparisons

I.                     Free Markets vs. Regulation vs. Government Ownership

A.                 So far we have mostly studied the economics of free markets, with some additional discussion about how regulation affects markets.

B.                 We now turn to a systematic comparison of three different ways of organizing production:

1.                  Free markets (laissez-faire)

2.                  Regulated markets (interventionism)

3.                  Government ownership (socialism)

II.                   Fallacies of Comparison

A.                 Fallacy #1: People often compare an ideal version of their preferred system with real versions of alternatives.  This always produces a biased result - how can the real world ever compete with an ideal system in someone's mind?

B.                 Fallacy #2: People compare the real version of one system to the ideal of that system, and reject it for falling short.  ("Perfect markets have no externalities, but real markets do, so we shouldn't rely on the market.")  But a system can fall short of an ideal, but still be better than real alternatives.

C.                Fallacy #3: People define away objections to their preferred system.  E.g.: "That's not 'real' socialism," or "That's not 'real' capitalism."

III.                  Fair Comparisons

A.                 Three main problems of systems of production:

1.                  Problems of ability

2.                  Problems of knowledge

3.                  Problems of incentives

B.                 Comparisons of ideal systems abstract from incentive problems, but not ability or knowledge.

C.                Comparisons of real systems consider all three classes of problems.

D.                Two fair comparisons:

1.                  Ideal free markets vs. ideal regulated markets vs. ideal government ownership

2.                  Real free markets vs. real regulated markets vs. real government ownership

IV.               Differences Between Ideal Systems: Problems of Ability and Knowledge

A.                 Suppose everyone voluntarily does their duty.  All systems are still not equally good ways of producing goods.

B.                 Problems of ability.  Ex:

1.                  Scale economies/firm size

2.                  Communication/red tape.

3.                  Coordination.

C.                Problems of knowledge.  Ex:

1.                  Choosing production techniques.

2.                  Finding out people's preferences.

3.                  Testing new ideas.

V.                 (Additional) Difference Between Real Systems: Problems of Incentives

A.                 People in the real world often won't voluntarily do their duty; they do what is in their self-interest.  With externalities, doing the socially efficient thing often conflicts with doing the privately optimal thing.

B.                 This is true of laissez-faire, interventionism, and socialism.

C.                Will changing the system change human nature?

D.                Examples:

1.                  People work only if rewarded.

2.                  People will innovate only if they are rewarded for success.

3.                  People will avoid "hare-brained schemes" if they suffer a penalty for failure.

4.                  People will lobby for monopoly privilege if it pays.

5.                  People will (may?) enslave others if it pays.

E.                 Future weeks will actually compare the ideal and the real versions of laissez-faire, interventionism, and socialism.