Econoclasm: Lesson Two

Let us return briefly to the lonesome world of Alice and Bob. For the transaction to truly benefit both of them, it should be obvious that they both have to know exactly what they are getting – that’s called the assumption of perfect information. If X turns to be less than Bob expected, or possibly no good whatever, Bob is not happier after all. Asymmetric information is common throughout the economy – generally, sellers know more about the product than buyers – but it’s obviously an inherent feature of Medicine. After all, the product for sale is expertise. 

Another assumption is that Alice and Bob both enter into this transaction freely and willingly. That’s actually hard to define. If Bob is starving and Alice has a pizza, is Bob really free to take it or leave it? You might argue that even if Bob gives Alice everything he possesses, and binds himself to her in servitude for life, he’s still better off because at least he isn’t dead. That may be so, but obviously this isn’t a world Bob wants to live in. 

At the very least, to protect Bob in this situation, there have to be a lot of people selling food, they have to be competing with each other and not colluding to hold up the price, and Bob has to know what each of them has on offer at what price, and be able to choose among them. That way he’ll get the best possible deal. If Alice controlled all of the food in town, she’d be the dictator, and you could hardly getting away with calling that a Free Market. But that’s actually the case if Alice has a patent and exclusive marketing rights to a medication Bob needs to survive – a situation that exists for many people in the U.S. today. 

If Bob does have choices, in order to make all these comparisons, prices need to be in common, measurable units, which is where money comes in. If Bob was exchanging, say, baseball cards for food they would be worth wildly different amounts to different food sellers, and trying to find the best deal would be nearly impossible. Bob would have to haggle with each of them individually before he could figure it out, and he might be dead by then.

I won’t go into the deep philosophical weeds about what money really is. Karl Polanyi calls it a “fictitious commodity.”  It’s worth something because we pretend it is. For money to work properly in the economists’ magical world, its value for each person has to be equivalent to a quantity of an imaginary entity called “utility.” Supposedly we go through life trying to maximize our utility, a mysterious psychological property, something like the satisfaction of our desires measured in standard units, so that $1 can be equal to 1 utile. People are presumed to be “rational actors” – they calculate exactly how to allocate their monetary resources to acquire the maximum number of utiles. I won’t keep you in suspense: people do not actually do this.

 

Next, we'll have more to say about the real world, including money, and some of the other always -- not sometimes, but always -- false assumptions that underlie the theory of the Free Market.™