Liberty, Equality and the Market

Market

A complex social institution created by humans to coordinate the actions of many people; more than just a physical or virtual place of exchange.

Features of a Market

1. Voluntary Transaction: Market exchanges are free and not coerced. Both sides able to walk away and assumed to be mutually beneficial.

2. Coordinated Through Prices: Prices coordinate exchange. Shortages drive up the prices and buyers/sellers react to prices.

3. Sustained by Rules: Markets depend on contract, property, labor and corporate laws. The state and market are not opposites, the state must support markets through laws.

Reasons to Regulate Markets

• Exploitation (unfair advantage)

• Equality (limiting wealth gaps)

• Paternalism (preventing self-harm)

• Externalities (harm to third parties)

Hayek’s Tin Example

Illustrates the market coordination. If tin were to become scarce, users just need to know the price went up to economize, without knowing the original cause.

Irrational Exuberance

When prices are bid well above sustainable levels (because buyers hope or expect that the price will keep rising). When it crashes, people lose lots of money. Coined by Joseph Stiglitz.

“In the shadow of the law”

Phrase by Kornhauser & Mnookin stating that all market bargaining depends on the state for security, enforcement, and sanctions.

“No such thing as a free market”

Ha-Joon Chang's concept: markets are always defined and regulated by laws. The real question is which rules the state should create, not market vs. state.

Capitalism

1. Interchangeable with “market economy”

2. For-profit businesses + private ownership of means of production,

3. (Critics) System enriching property owners by exploiting workers.

Market Socialism

An economy that uses markets, but where the workers collectively own the means of production.

Virtues of a Market Economy

• Efficiency: best use of resources

• Freedom: respects individual liberty and prevents tyranny

Welfare Economics

Branch of economics exploring how to set up markets to maximize efficiency/social welfare. Influenced by utilitarianism.

Utilitarianism

Philosophy striving for "the greatest happiness of the greatest number" (basis for economic "utility functions").

Pareto-Efficient

A market state where it is impossible to make anyone better-off without making someone else worse-off.

Pareto-Improvement

When some people are made better-off without making anyone else worse-off (based on subjective, individual preferences).

Ideal Market Conditions

Requires a competitive market (not dominated by a few) and all costs of production fully captured/internalized in prices (no externalities).

Externalities

Costs passed on to third parties or society (e.g., pollution) that are not captured in market prices.

Deadweight Loss

Potential gains in welfare that are not realized when ideal market conditions are not met (e.g., monopolies charging higher prices).

Market Failure

A situation where the unregulated market fails to achieve the most efficient outcome (e.g., monopolies, externalities).

Efficiency Case for Regulation

Regulating markets (e.g., breaking up monopolies, taxing carbon) can improve efficiency and fix market failures.

Liberals vs Libertarians

Both value freedom/liberty highest, but libertarians are more strictly opposed to government regulation.

Markets and Freedom

• Direct: The freedom to enter into contracts and make exchanges is itself an important form of liberty (Amartya Sen).

• Indirect: Market freedom supports other freedoms, like living as you choose and democratic/political freedoms (Milton Friedman).

Critiques of Markets and Freedom

Poverty makes freedom to exchange meaningless if you can't afford goods; Wealth allows the rich to influence politics and concentrate political power.

Other Values to Consider

Equality, Fairness, Dignity (e.g., of the human body), Environmental sustainability, and Happiness (beyond just satisfying consumer preferences).

Redistribution

The operation of the market in recent years has trended towards increasing inequality.

Nozick’s Argument on Taxation

Argues that if slavery is unjust (forcing someone to work for another), then forcing someone to work is unjust. Forcibly confiscating a portion of someone's income is morally equivalent to forcing them to work. Therefore, coercive taxation is unjust and equivalent to slavery.

Liberty Argument against Redistribution

Argues that liberty requires the absence of coercion. Because redistribution relies on coercive taxation, it abridges liberty. For this to make redistribution unjust, one must also argue that redistribution lacks appropriate justification.

Property Rights Strategy

The argument that redistributive taxation is unjust because it violates individuals' property rights over their pre-tax income. It presupposes that individuals have natural property rights that precede the state.

Property Rights

An agent has property rights over an object if they have the right to possess, control, use, and transfer that object without interference from any other agent.

Locke’s Labour Mixing Theory

John Locke's theory that individuals own their own bodies and labour. By mixing their labour with unowned aspects of the natural world (the "state of nature"), they make those things their property.

Locke’s Theory Applied to Income

Because individuals own their labour, they can sell it for wages, or sell property for money. Through these voluntary exchanges, individuals acquire natural property rights over their income and wealth.

Critiques of Locke’s Property Rights

1) Presumes the external world is initially unowned rather than jointly owned

2) The labour-mixing theory is logically peculiar;

3) It tolerates virtually unlimited inequality in principle.

Murphy and Nagel’s Critique of Property Rights

Argues that natural property rights preceding the state are incoherent. Money and labor markets only exist because of the state (courts, law enforcement, collective agreement). Property rights are artefacts of the state, which requires taxation to exist. Thus, taxation cannot violate property rights.

Rawls’ Theory of Justice

John Rawls' theory that societies are collective ventures for mutual advantage. Assuming citizens are of equal moral value and fully cooperating, justice requires that the terms of social co-operation (distribution of costs and benefits) must be fair ("justice as fairness").

Strict Equality of Income and Wealth

The principle that justice requires equal distribution of wealth. Critiqued because it would deem an unequal distribution (e.g., $50, $40, $30) unjust even if it makes everyone much better off than an equal distribution (e.g., $10, $10, $10).

The Difference Principle

Rawls' principle that social and economic inequalities must be arranged to the maximum benefit of the least advantaged. People can benefit from their natural endowments only if doing so improves the position of the worse-off.

Formal Equality of Opportunity

The principle that all have the same legal rights of access to all advantaged social positions. It simply requires outlawing institutional discrimination on arbitrary grounds (e.g., making it illegal to reject Debbie based on race).

Fair Equality of Opportunity

The principle that those with the same level of talent, ability, and willingness to work should have the same prospects of success regardless of their initial social class or income bracket.

Rawls on Natural Inequalities

Rawls argues it is not unjust that people are born with unequal natural endowments (e.g., IQ, physical strength). However, it is unjust for social institutions to convert those natural inequalities into unequal social advantages unless doing so maximizes the position of the worse-off.

Critiques of Rawls’ Indifference Principle

1) It could require the middle class to accept a much lower standard of living for very modest increases to the worse-off.

2) It gives insufficient weight to individual responsibility (e.g., Kymlicka's gardener and tennis player case).

Patterned Principles of Distributive Justice

Principles claiming that distributive justice is achieved when the distribution of resources across a population matches a specific pattern (e.g., equality, need, or benefit to the least advantaged). Nozick argues all such principles are false.

Wilt Chamberlain Argument

Nozick's thought experiment: If a just, equal distribution (D1) is altered by 10,000 people voluntarily paying 25c to Wilt Chamberlain, it creates an unequal distribution (D2). Nozick argues D2 cannot be unjust if it arose from just steps (voluntary transfers), proving patterned principles false.

Just Steps Principle

Nozick's principle that "whatever arises from a just situation, by just steps, is just." Because voluntary transfers are just steps, any resulting distribution must be just, contradicting patterned principles that would deem the new distribution unjust.

Replies to Wilt Chamberlain Argument

1) The "just steps" principle begs the question; unjust states can arise from individually just steps (like collective action problems/pollution).

2) Nozick ignores the possibility of negative externalities that might accompany voluntary transactions.

Firms

Carry out most production in the economy and employ lots of people.

They also wield significant political and economic power.

Coase: Why firms exist

Transaction costs to buy or sell goods or services, aside from the cost of transaction can be high sometimes. Firms reduce cost of transactions by replacing constant market bargaining among sole traders with managerial authority.

Instead of negotiating every task, managers direct employees, making production more efficient.

Employment

A relationship with authority. These types of contracts are incomplete as they don’t specify every type of task that has to be performed by an employee.

Negative Liberty

Freedom as non-interference; the absence of agents who forcibly prevent or penalize a choice.

Positive Liberty

The ability, given one’s resources and means, to realise a possible world in which they make a specific choice.

Neo-Republican Liberty

The absence of a power of arbitrary interference by another agent, regardless of whether that power is exercised or not.

Private Government

Elizabeth Anderson’s term for firms that exercise extensive power over employees both during and sometimes outside of work.

Robert Mayer’s Defense of Firm Authority

The idea that authority-relations are not problematic because workers voluntarily consent to their own powerlessness via contracts.

Anderson’s Response to Mayer’s Consent

Consent to one option within a set does not justify the entire set of authority-relations if there are no realistic alternatives.

Tyler Cowens’ Overall Response to Anderson

• Competitive firms offer better treatment and have an incentive to attract and keep employees

• Employer control can serve to protect other employees, not just exercise arbitrary powers.

• Firms benefit consumers who are also workers.

• Having a job is better for wellbeing than unemployment

Game Theory

The field of study interested in cases where what it is rational for one party to do depends upon what it is rational for some other party to do. Game theorists assume "players" are rational, self-interested actors seeking the best possible outcome for themselves.

Prisoner’s Dilemma

A famous game theory scenario demonstrating that if each player acts in their rational self-interest, they will realize an outcome that is worse for all of their interests than if they had acted otherwise (e.g., both prisoners confessing rather than both of them keeping silent).

Equilibrium Outcome

The outcome that will inevitably be realized if each player acts rationally in their own self-interest (e.g., both parties confessing in the Prisoner's Dilemma). This is not Pareto-efficient.

Optimal Outcome

The best possible outcome for all parties involved. In the Prisoner's Dilemma, the optimal outcome (both keeping silent) comes apart from the equilibrium outcome and is not Pareto efficient.

Collective Action Problems

Arise when a good might be produced (or harm averted) by a group if a sufficient proportion of members contribute to a scheme, but the group fails because an insufficient proportion finds it rational to contribute. Examples include climate change.

Tragedy of the Commons Simplified

1. Group shares common resource

2. It is rational for each member to exploit that resource in a way that imposes costs on all but only benefits themself

3. Individual benefits exceed their share of the costs

Rational Choice Theory

A broad tradition using economic tools to explain human behavior, based on the fundamental presupposition that individuals are rational and act to maximize expected utility.

Expected Utility

The sum of utilities weighted by probabilities. For any choice between acts, a rational agent performs the act with the greatest expected utility (e.g., if act x has a 50% chance of $10 and 50% chance of $20, expected utility = $15).

Paradox of Voting

A specific Prisoner's Dilemma where it is not in any individual citizen's rational interest to vote (costs outweigh expected utility), yet it would be disastrous for everyone's interests if no one voted. The equilibrium (no one votes) is highly sub-optimal.

Rational Ignorance

Occurs when it is irrational to take on the costs of gathering information (time, effort, resources) because the expected utility of doing so is insufficiently great. Because the expected utility of voting is incredibly low, investing time in gathering political info is generally irrational.

Bryan Caplan: Rationally Irrational

The theory that voters are not merely rationally ignorant, but actively "rationally irrational" - meaning it can be practically rational for them to be theoretically irrational in their political beliefs.

Practical vs Theoretical Rationality

Practical rationality concerns the rationality of action (maximizing utility/preference satisfaction). Theoretical rationality concerns the rationality of belief (basing beliefs on evidence).

Preferences over Belief

Caplan's suggestion that people have preferences about what they want to believe (e.g., religious or ideological identities). If these preferences are strong, people will rationally (practically) depart from the evidence, making them theoretically irrational.

Market vs Political Irrationality

In markets, theoretical irrationality carries heavy individual costs (e.g., buying a 2-bedroom house thinking it's 3). In politics, there is no individual cost to irrationality because one vote is vanishingly unlikely to change the outcome, so citizens are "free" to indulge in preferred beliefs.

Politics as Commons

Caplan's argument that politics has a built-in externality. An irrational voter does not just hurt themselves; they hurt everyone by making misguided policies more likely. Because the cost of voter irrationality is external (paid by others), voters freely indulge in it, causing socially injurious policies to win.

Caplan’s Proposed Solutions

To solve democratic failures caused by voter irrationality:

1. Voting licenses,

2. Limiting scope of the government and expanding private sector where individuals bear the costs of their own irrationality

Critiques of Caplan

Critics argue that:

1. Groups solve Tragedies of the Commons all the time, so why not this one?

2. Even if rationally irrational, voters’ biases might still accidentally accord with their substantive interests

3. Empirical research on these issues is ongoing

Hotelling’s Rule

Under certain market conditions, competing firms tend to offer very similar products or positions because they want to capture the largest possible market. It’s political equivalent is the Median Voter Theorem.

Median Voter Theorem

The idea that political parties have an incentive to move towards the position of the median voter, because doing so gives them the best possible chance of winning an election.

Elite Bias

The idea that wealthy and powerful people disproportionately wield political influence.

Four Theories on Who Governs

• Majoritarian Electoral Democracy

• Economic Elite Domination

• Majoritarian Pluralism

• Biased Pluralism

Majoritarian Electoral Democracy

Majority of citizens determine policy

Economic Elite Domination

Wealthy citizens have the greatest influence on policy

Majoritarian Pluralism

Competing interest groups produce broadly representative outcomes

Biased Pluralism

Interest-group competition exists, but wealthy groups have major advantages

Gilens and Page

Found changes in preferences of average citizens had almost no independent effect on policy changes.

Criticisms of Gilens and Page

• Very low coefficient - Only 7.4% of results could be explained

• Many issues are highly complex, ordinary citizens are not directly tested

• Rich and poor often agree. Middle and lower income people often get policies they want

Lindblom’s Argument

1. Businesses respond to economic incentives

2. Business behavior affects economic outcomes

3. Economic outcomes affect ordinary people

4. Politicians have incentive for citizens to be happy so they can maintain power

5. Politicians don’t damage business incentives

Structural Power of Businesses

Businesses may lobby politicians but they do not necessarily need to. Governments are naturally highly deferential to businesses.

This is because impact on incentives of a business will ultimately have an impact on citizens’ interests, such as via effects on unemployment.

Lindblom on Democracy and the Market

• Democracies are imprisoned by the market

• Political leaders face a penalty for restricting the activities of a business at least where doing so negatively impacts employment, investment and business incentives in general

• This is why democracies are highly constrained in their ability to regulate business activities.

Zowlinski on Price Gouging

• Thinks that price gouging is not unethical and should not be banned

• Standard cases of price gouging provide great benefit to those in desperate need.

• Attempts to prohibit this practice will harm individuals who are already vulnerable.

Price Gouging

Excessively raising the prices of necessary items in an emergency.

Two Aspects of Price Gouging to Consider

• Is price gouging unethical?

• Should price gouging be banned?

These need to be kept separate. Even if price gouging is unethical, it doesn’t follow that it should be made illegal. The government shouldn’t always be policing morals, especially when those morals are debated.

Exploitation Argument against Price Gouging

Exploitation is mutually beneficial exchange of unfair terms. Such as Person B offering to rescue Person A from a pit only if Person A gives up all their life savings.

In this case, Person B, the price gouger takes unfair advantage of people’s desperation or lack of options. The exchange is still exploitative even if its mutually beneficial.

If the prices a seller charges are deemed unfair, regardless of whether buyers are willing to pay for it, it can still be deemed exploitative.

Zowlinski’s response to Exploitation Argument

• Even if buyer prefers a cheaper price, buyers always prefer a cheaper price, so what’s going wrong here?

• Our sense of a “fair price” is a bad guide on how market pricing works (and ought to work) when there’s a supply or demand shock

Efficiency Argument for Price Gouging

• Microeconomics theory states that an increase in demand for a good will also increase its price.

• This causes sellers to increase their supply as they have more incentive to make money

• Buyers also think hard about whether they really need the good given its new price.

Nonworseness Principle

If A has the right to not transact with B, and where transacting with B is not worse for B than not transacting at all, then it cannot be seriously wrong to engage in this transaction, even if the terms are judged to be unfair by some external standard.

Interaction Principle

If you condemn a price gouger for charging high prices, why not condemn everyone who does nothing to help? Ignoring the victims entirely arguably shows less respect for their humanity than as treating them as a trader in a market.