Prof. Phillip J. Bryson

1
Markets vs. Hierarchies

• Prof. Phillip J. Bryson
• Marriott School
• Brigham Young University

2
Markets
Market in Istanbul, Turkey

• What are markets?

3
Markets
Market in Istanbul, Turkey

• Markets are institutions of buying and selling on
  the basis of voluntary exchange.
• Can you draw one?

4
Free Minds, Free Markets
What does the S curve show? What does the D
curve show? Is freedom shown in these
curves? What role does the government play in
this?
5
Free Minds, Free Markets
Supply shows what sellers wish to do, Demand
shows what buyers wish to do, and both express
the freedom of economic agents to pursue their
own interests.
6
Hierarchies

• What are Hierarchies?
• (Bureaucratic) Institutions or Organizations
• Why are they bureaucratic?

7
Hierarchies

• Because they are designed to allocate resources
  without the use of markets.
• They use strict lines of authority

8
Transactions and Efficiency

• What is the fundamental unit of analysis in
  economics?
• The fundamental unit of analysis is the
  transaction.
• What are transactions costs?
• Where parties must bargain particular terms, for
  example, higher transactions costs are incurred.

9
Transactions and Efficiency

• In either markets or hierarchies, should
  production processes be performed efficiently?
  Is that an important criterion of success?
• Why?
• What is the goal of markets and hierarchies?
• The greatest possible happiness of the people.
  (To maximize societys utility or
  satisfaction.)

10
Why Is Efficiency Important?

• Consider the economic notion of efficiency. For
  a given set of available resources, can more than
  one allocation be efficient?
• Numerous allocations will be possible and
  efficiency doesnt require a unique outcome.

11
Why Is Efficiency Important?

• Alternative distributions of resources offer
  diverse outcomes. What is Pareto optimality?
• It is an allocation of resources achieved in the
  social situation where, given some distribution
  of incomes or resources
• no individual can be made better off without
  making someone else worse off.

12
Economic Systems

• What is an economic system?
• A set of institutions (practices and
  organizations) that will allocate scarce
  resources among competing uses.

13
Economic Systems

• Give me an example or two of economic systems.
• Capitalist or Socialist systems, which allocate
  scarce resources
• through markets or through a central planning
  agency.
•  

14
The Anti-Market Mentality

• Who was the spiritual father of this hostility
  and the theorist of scientific socialism?
• Karl Marx.
• Who was the great, real-world builder of the
  Marxian system?

15
The Anti-Market Mentality

• Vladimir Ilyich Lenin, of course.
• He said ???????? What does that mean?
• So what is Who whom? supposed to mean

16
The Anti-Market Mentality

• Contrast to bargaining mentality or to a western
  sales mentality.
• Who gains in the normal transaction? Do both
  gain, or is one party always the sucker, the
  exploited participant?

17
The Socialist Dilemma

• What is the efficiency dilemma for socialism
• To achieve efficient allocation without markets.
• All goods need to be produced at the lowest
  possible cost,
• The right mix of outputs must be forthcoming for
  the benefit of consumers, and
• the right levels of savings and investment must
  be provided. Generally,

18
The Socialist Dilemma

• There must be no way to increase consumer
  satisfaction by any reallocation of societys
  resources.

19
The Socialist Dilemma

• Could supercomputing generate an efficient
  allocation of resources for a complex, modern
  economy?
• In my view, computing an efficient allocation for
  a complex modern economy is not feasible.

20
The Socialist Dilemma

• Why might it be impossible to achieve this?
• By the time all preferences and production
  possibilities were determined, recorded and
  digitized, they would already have changed.
• Even with only two people, it may be impossible
  to determine how to arrange their activities to
  help one without hurting the other.

21
Soviet-type Central Planning

• The fundamental planning problem
• The objective is to destroy markets so the
  property and power (to set prices, etc.) is taken
  away from the capitalists.
• But planners are removed from the production
  process and dont have the information available
  to producers.

22
Soviet-type Central Planning

• How can planners get sufficient information to
  deal with the tremendous complexity of the
  economy?
• Only from managers of the enterprises.

23
Soviet-type Central Planning

• This disparity in the need for and availability
  of information gives rise to
• Principle/agent problems.
• Incentive compatibility problems.
• The solution(?) to the problem?
• Establish quotas gross output targets for
  producers.
• This provides the enterprises with the objective
  securing soft target.)

24
The Gross Output Target

• The primary objective bury the capitalists.
• Who said they would bury us?
• What did Khruschev mean with this threat?
• They would shame capitalist systems by superior
  production!

25
The Gross Output Target

• So the Soviet Union sought above all else rapid
  economic growth.
• Frenetic pursuit of growth results in
• No quality dimension,
• No innovation,
• Environmental degradation.

26
The Information Problem in Central Planning

• Material Balances, the committee approach to
  allocation.
• Half the committee works on sources, the other
  half on distribution.
• Send letters to suppliers and buyers for
  quantities.
• Make plan and inform enterprises. Hear their
  problems and revise.
• 7-13 iterations should do.

27
The Information Solution

• Input-Output Analysis would solve the information
  problem. Who came up with Input-Output analysis?
• Wassily Leontief, from St. Petersburg. He won the
  Nobel in 1973

28
The Information Solution

• In a matrix of inputs (columns) and outputs
  (rows) all industries are listed.
• Invert the matrix to solve for precise planning
  quantities.
• But Leontief was promoting bourgeois doctrine.
  Why?

29
The Information Solution

• By the time he had published his results, he was
  a bourgeois economist at a bourgeois university
  Harvard.
• They had to wait for Kontorovich to develop
  linear programming.

30
Plan Failure

• Plannings failure to achieve consistency and
  productive results led to private efforts to meet
  needs.
• Extensive growth was possible, especially early
  on, but intensive growth was not. Productivity
  stagnation was the nightmare of Brezhnev.

31
Plan Failure

• Private efforts to manage resources began with
  the enterprises sending out their Tolkach
  (expediter, pusher) to find the resources the
  plan had misdirected.
• From this the second economy developed, and it
  was huge.

32
How Would You Organize?

• Let us assume that 2,000 Saints moved to a newly
  discovered and unpopulated island in the Puget
  Sound region to start a new life and establish
  Ytopia?

33
How Would You Organize?

• Could this be done even without a government to
  pass laws?
• Who would tell the people what to do, what to
  produce? Without a government and economic plan,
  why would anyone want to produce anything?

34
How Would You Organize?

• If whole economies cant be organized
  efficiently, can individual economic
  organizations function efficiently?
• Some corporations are also extremely large with
  multiple divisions and widely diverse activities.
  Like those corporations, an economic community
  would face the tasks of coordination and
  motivation.

35
How Would You Organize?

• Specialization is the key to societal material
  wealth.
• Adam Smith told how complex were the processes
  and from what distances the materials and parts
  were gathered to produce pins.
• Milton Friedman told a similar story about
  producing the simple pencils a couple centuries
  later.

36
How Would You Organize?

• To coordinate effectively, widely dispersed
  information must be available for planning. A
  manager could either
• collect it from lower hierarchical levels of the
  organization or
• let those individuals who have it use it with
  decentralized decision powers to produce and buy,
  sell and consume.

37
How Would You Organize?

• Prices summarize all market knowledge and
  information between firms and consumers.
• What incentives are available to motivate people
  to act on their information?

38
How Would You Organize?

• Adam Smiths form of regulation of the market
  system was the invisible hand. What was that?
• The forces of market competition.

39
Transactions Costs

• A creative new approach to economic analysis
  suggests that economic activity and organizations
  are arranged so as to minimize transactions
  costs.
• Who developed this idea?
• I thought youd recognize Ronald Coase.

40
Transactions Costs

• Why are some transactions conducted through
  markets while others are not.
• Ronald Coase (Nobel, 1991) pointed out that
  transactions costs depend on the way a
  transaction is carried out.

41
Transactions Costs

• Coase taught that transactions agents will tend
  to adopt institutional arrangements that minimize
  transactions costs. Generally, they are the costs
  of running the system, of coordinating and
  motivating.

42
Transactions Costs

• Coordination costs. It is necessary to determine
  prices and other details of transactions, to
  locate and negotiate with potential buyers and
  sellers. Producers must research buyers tastes
  and determine market demands. Buyers must search
  for the best prices and characteristics of goods.

43
Transactions Costs

• Transactions costs also include the benefits lost
  when buyer and seller matching is non-optimal or
  when worthwhile transactions dont come about.

44
Transactions Costs

• Motivation Costs.
• First, informational incompleteness and
  asymmetries can cause transactions costs.
• Second, imperfect commitment causes them when
  parties are unable to commit themselves to follow
  and implement the contract.

45
Transactions Costs

• When agents must decide whether to follow through
  on threats and promises they would like to make,
  but which, having made, they would later like to
  renounce, transactions costs must be incurred.

46
Attributes of Transactions

• The specificity of required investments. High
  specificity means the investment cant be used in
  other transactions.
• The frequency with which transactions occur and
  their duration.

Thuan Phuoc Fish Market
47
Attributes of Transactions
Thuan Phuoc Fish Market

• The complexity and the uncertainty (about the
  transactions required performance).
• The difficulty of measuring performance
• The connectedness of the transaction to other
  transactions

48
Viability of the Theory

• The theory that economic activity and
  organizations are designed to minimize
  transactions costs is helpful conceptually,
  problematic in two ways.

49
Viability of the Theory

• First, Production costs f (technology, inputs)
• Transactions costs f(organization of
  transactions).
• But both depend on organization and technology
  separating and measuring the two is difficult.

50
Viability of the Theory

• Second, the notion that firms will organize so as
  to minimize transactions costs (as Coase
  suggests) is problematic.
• Why should employers minimize total transactions
  costs rather than those costs which they
  themselves must bear?

51
Viability of the Theory

• The standard answer is that employees costs will
  be taken account of where competition forces
  employers to do so. But that greatly reduces the
  range of application of the theory. Competitive
  forces are not always sufficiently strong.