Markets must become competitive

ICYMI, I was in the WSJ earlier this week on my usual shtick: economics is good.

Nearly every week, someone writing for a major news outlet argues that economics has failed. Our models are too abstract. Our predictions are always wrong. President Trump’s recent firing of Bureau of Labor Statistics Commissioner Erika McEntarfer is the latest notable example of this anti-economics sentiment.

Let me make what appears to have become a radical argument: Simple economics is surprisingly good at making real-world predictions.

I’ll share the full text here when I can.

Below is an expanded version of a post from 2021.

Prices emerge from individuals’ interactions and bargaining. The slogan that I stole from Joe Ostroy is that maximization precedes prices. This slogan stands in contrast to the standard, price-taking approach, where prices must exist before people act. With price-taking, prices precede maximization.

Word games are fun, but who cares? The two visions of markets lead to different understandings of how markets work and, ultimately, different policy recommendations.

In the standard approach, a market is competitive (or not) by assumption. In jargon, it is exogenous whether people are price-takers or not. As IO economists have long realized, it is problematic to think of the level of competition—or more easily measurable characteristics like concentration—as exogenous. They are instead equilibrium outcomes. Something else determines them. One benefit of the price-taking model is that it’s easy to use. Draw supply, draw demand, and point and the intersection. Every textbook starts there.

To get beyond price-taking, we must recognize that markets become competitive. It’s an equilibrium outcome that plays out through time. As the Austrians say, the market is a process.

Entrepreneurs and How Prices Emerge

There is actually one textbook that explicitly teaches markets the way I recommend. The answer will surprise you—or not, if you’ve read this newsletter.

Armen Alchian and William Allen’s Universal Economics starts with a simple bargaining situation and shows how prices emerge. (Thanks to Bryan Cutsinger, a great teacher of price theory, for pointing me to their exposition of this.)

Let’s go through Alchian and Allen’s example.

We are visiting a camp where hurricane refugees are living. Monthly, each refugee receives Red Cross parcels with 20 bottles of water and 20 granola bars. (The old editions had cigarettes and candy, which sounds much more fun, but we'll stick with water and granola bars.) To start ...