Bargaining and Perfect Competition

A few days back me and some friends my of mine got together for tea. Tea get togethers involve some good food, good conversations, and the obvious element ‘tea’. During this tea session the conversation twisted and turned from one topic onto to the other. One of the topics that my friend shared was how she cannot bargain while shopping and how her mother is excellent at it. As per my knowledge bargaining is done while street shopping and not while you shop in big stores or malls where you know the price of the item you buy by the price tag that accompanies it. The economics teacher in me ventured to ask her further about why she could not bargain and why she thought that her mother is good at it. This led me to understand something economists have known for a long time about how some markets function. It enhanced my understanding how the theory is enacted by its players in real time.

To give you a brief about the theory, markets can be of two major types; perfectly competitive and imperfectly competitive. It is better to explain these markets by their characteristics using examples. Firstly, a market is a place where buyers and sellers of product(s) come together. A market for a small business like a photocopier(copier) who provides you with paper copies of any printed material is an example of a business operating in a perfectly competitive market. Perfectly competitive markets display some characteristics which are as follows –
Firstly, there are many buyers and sellers in the markets. Secondly, the product offered by all the sellers is similar in its characteristics. Thirdly, it is very easy for anyone to enter or exit this market in the capacity of a seller. Finally, both the buyers and sellers are well informed about the market especially about the prices. Apply these characteristics to the copier business, one easily identifies that it is in a perfectly competitive market.

Imagine that an experienced bargain shopper wants to buy chappals in a street market. There are many shops who sell the chappals and many buyers who want to buy the product as well. This satisfies the first condition of perfect competition. As many vendors offer similar kind of chappals the second condition of perfect competition is fulfilled. Also, it is easy for anyone to set up shop at a street market, thus satisfying the third condition for perfect competition.

It’s only the information about the price of product that is not known. One of the main reasons why it so is because the market for chappals is not as big as the market for photocopiers. Hence, the seller has all the incentive to quote a higher price as the buyer is not aware of the price of the product. This will earn the seller higher profits whereas as the buyer will be at a loss for paying higher price. The only way the buyer can gain is buy discovering the price of the product. This will complete the final condition of a perfectly competitive market i.e. buyer and seller are perfectly informed about the market.

The way in which the price is discovered by the buyer (bargainer) is what we know commonly. The buyer approaches the first seller and asks for a price that is well below the selling price set by the seller. Bargaining ensues usually without a sale. The buyer then moves on to another seller but with the information about the price at which a seller might settle given that the products are similar. The process may be repeated with another seller till the price is discovered by the buyer leading to fulfillment of the final condition of a perfectly competitive market. Thus, those who complain that they cannot bargain in a market offering similar products should de facto accept a loss in that purchase.

The Schumpeter Diagnosis

I have been wondering about the validity of Creative destruction[1]. The concept has held true for a long time. Product and process innovation has led to new production units replacing the old in turn causing disruption in the labour markets. Labour associated with old manufacturing processes and/or products lose their jobs but new jobs are gained in the new production processes and/or products. In the time between loss and creation of jobs there will be a spurt in unemployment. The expectation is that the unemployed learn the skills to employ themselves in the new processes and/or products created. The bottom line is to improve productivity of labour and utility of the product to the consumer by creating new processes and/or products. But all throughout history labour has revolted against this creativity. And all throughout history the labour has been proven wrong in the long run. Creative destruction has undoubtedly led to improvement in living standards and economic well-being.

The question that I have is whether this relation will continue into the future. Until now people (labour) have been using machines (capital) to produce goods. But what if capital can produce goods without our help. There would be no need for labour. Labour will be replaced by capital without the need for them to upgrade their skills to adapt to new processes and/or products. This is what is being observed now with the advent of Artificial Intelligence (AI).[2] It is not as easy as saying all people will lose jobs immediately and the machines will take over completely soon. The structure of employment will change among other things. The jobs market might be characterized with few top level and middle level jobs and large number of low level jobs.[3] The disruption in labour market might be observed more in the developed or the so-called modernizing economies rather than in less modernizing economies. 

Coming back to the original issue of creative destruction, I doubt whether the modernizing world will be able replace jobs in the long-run. I had initially thought that we might have to get used to long periods of high unemployment rates i.e. high natural rate of unemployment but it might not be in single digits any more not due to frictional but incessant structural changes. Some countries, for example Switzerland, have already begun to see the impact of continuous technological improvements on employment. They have implemented Guaranteed Minimum Income schemes, where, as the name says, families are guaranteed minimum income by the government to counter the loss of income because of loss of employment [4]. To conclude, this time its different and creative destruction will not have a familiar outcome this time around or maybe there will only be destruction without creation in the long-run.

---

[1] Schumpeter, Joseph Alois. Capitalism, Socialism and Democracy. London: Routledge, 1992. Print.

[2] Ford, Martin. Rise of the Robots: Technology and the Threat of a Jobless Future. New York: Basic, 2016. Print.

[3] IBID

[4] IBID

Short-run, Long-run

I am currently reading a fascinating book called "Economics in one lesson" by Henry Hazlitt. It was first written in 1946 and remains a classic in Economics literature. Looking at the rate at which I publish my posts I can hopefully publish a review of this book sometime in the near future.

The book challenges various policy decisions made by the government in various areas. Among the two fallacies it examines one is about the capability of governments to evaluate the long-term consequences of their policies. The book argues that governments can't think of the effects (negative effects) of the policies they implement to fix short term problems that arise in an economic system. Some of the long-run effects of the myopic policies that the book examines are that of measures of protectionism, fixing unemployment and tax policies. 

This got me thinking on a peculiar case not mentioned in the book. It is that of climate change. Climate change was not of concern back in those days. Today the policy makers are aware of the effect that climate change will or can have in the future. Taking action on errant polluters could lead to large job losses in the immediate future. They know that implementing appropriate environmental restrictions on economic (and non-economic) activities will help achieve climate change objectives. Hence, in this case it would be wrong to say that policy makers do not know the long-term effects of policies they are going to implement. 

One fallacy in the book is that if so many fallacies existed in the policies implemented by the U.S government that it should have long term impact then why has the U.S prospered over the long-run. Now those who have read the book might argue that it deals with policies only for narrow interest groups, but that is not the case with all the fallacies that the book considers. Also, many of the policies discussed are simultaneously into play which should compound the negative effects of not considering the long-run consequences. This brings me back to the question. Why has the U.S been prosperous over the long-run?

Whatever I could decipher from the reading I have done till now tells me that there were parallel policies that were implemented which negated the effects of short term-ism. This conclusion is from the way U.S managed critical junctures in its history (ref: Why nations fail? by Darren Acemoglu and James Robinson) Also, managing the short term problems is necessary to keep a balance to lead to prosperity. Who is to say that leaving things to the market forces might not lead to some social disaster in the long-run?

Man City vs West Ham 28/08/2016

It was around 2 months ago that Pep Guardiola took over as the manager of Manchester City Football Club (MCFC). Jose Mourinho at Manchester United Football Club(MUFC) and Antonio Conte at Chelsea Football Club(CFC) had made it a season to look out for. These many top managers had not managed in the Premier League before. As of now the following managers have won the leagues in different countries. 

1. Jose Mourinho (MUFC) - Portugal, England, Italy and Spain 
2. Pep Guardiola (MCFC) - Spain and Germany 
3. Arsene Wenger (Arsenal) - England 
4. Antonio Conte (CFC) - Italy 
5. Jurgen Klopp (Liverpool) - Germany 
6. Ronald Koeman (Everton) - Netherland 
7. Claudio Ranieri (Leicester City) - England 
8. Claude Puel (Southampton) - France 

I am watching the above mentioned match. It's the end of first half and MCFC are already up 2 goals to Nil. West Ham players' body language is not very encouraging. They have suffered staggering number of injuries to some of their very key players at the start of the season. These include Dimitri Payet and Aaron Creswell among others.

The game till now was completely dominated by MCFC. Sharp passing, quick one-twos and great possession. All hallmarks of Pep's style of play. Going into the second half it seemed that West Ham will concede more goals.
Come second half things have changed and kudos to the Pundit who's views I read on Skysports.com. He was spot on. This Pundit said that things are different in England. In Spain, opposition does not start defending until opposition teams bring the ball till the half way line. This allows teams to "build their attack from the back".

In the second half West Ham have pressed high up the field while defending. The "build from back" backfired. Willy the goalkeeper was seen panicking with the passes. There are as many West Ham players in MCFC's half as many as MCFC players. This also got them a goal from Antonio. West Ham have also maintained a very high defensive and disciplined back five evidenced by the number of offsides in the second half. Raheem Sterling, Nolito, etc did not see as much of the ball as in the first half.

Slavin Bilic is a great manager but I am wondering whether MCFC is this predictable.

The curious case of recoveries in UK and US post recession

     Another article from The Economist that I found interesting was published under the section Free Exchange: "The price of getting back to work" (issue of February 1st 2014). 

     Post 2008-09 there was a slump in GDP of both the economies. The American GDP bounced back relatively quickly but the employment in contrast suffered a more a dramatic decline. In case of Britain it was completely opposite; the GDP declined quickly without much downturn in employment as compared to US. The picture below taken from that very own article will help in visualizing the scenario. 

    

     Here I would like to quote what Paul Bowles has written in his book Capitalism - a short history of a big idea. He mentions business cycles under Capitalism and Crisis. 

     "In the boom period of the cycle the profit expectations are high and investment is high. The demand for labor is high and as a result unemployment falls and wages start to bid up. However, after a while, the rise in wages eats into the capitalists profits and creates a 'crisis'; the crisis of profitability. This is solved by capitalists reducing their investment levels, with the result that growth falls and unemployment increases until workers are disciplined to accept lower wages; at this point profit expectations pick up and the whole cycle is repeated".

     Though this maybe the central idea of a business cycle many aspects about the paragraph above can be debated. If this general idea is applied to the situation seen in the graph, the puzzling thing is, the divergence in the unemployment-GDP relation in the Britain and US economies.

    According to the The Economist article the US had a normal recession whereas Britain didn't and it can be explained by what they call 'productivity puzzle'. In US the weak demand, which accounts for output loss led to shortfall of jobs. In contrast in Britain falling demand has been accompanied by strange decline in workers' productivity. Falling productivity cushioned the economy against large jobs losses, since more workers were needed to do the same amount of work. As it reflected the loss of productive capacity, it led to higher inflation. The annual inflation in Britain has been double that of US since late 2007. 

   

This is where the even more interesting part comes in. Bill Martin and Robert Rowthorn, of the University of Cambridge, argue that this productivity puzzle has an opposite causation effect: 'wages did not fall in response to declining productivity; declining productivity was instead a consequence of falling real wages'. Putting it simply; as the nominal wage rise in Britain was 1.6% and inflation was more than 3% the real wages fell by 7.8% making the labor cheaper than the prices of goods and services. Hence the moderately high inflation was the difference between a jobless recovery and a job-filled one.

   

China's Economy

As mentioned in my introduction I am going to share what I read and experience. Well most of my reading nowadays is from some interesting books I have collected related to economics and my subscription to "The Economist".

I read an article in 'The Economist' ( issue of January 25th 2014, pg 59), under the Finance and Economics section. The title of the article is "China's economy - In three parts". The author of the article says that to understand China's economy, it would be helpful to think in threes. Three forms of growth: in supply, demand and credit.

The part that interested me the most was the one about how credit is spent. According to Richard Werner of Southampton University, credit spending can be divided into three categories.

1. Credit can be spent fruitfully on new capital and infrastructure which increases the economy's productive capacity. Lending of this kind adds to both demand and supply which results in higher economic growth without higher inflation.

2. Credit can also be spent wastefully, either on consumption or on misconceived projects such as coal mines without markets. These loans add nothing to the economy's productive capacity, but they do add to the demand. They make a claim on the economy's goods and services, without adding to its ability to provide them. Credit of this kind results in higher inflation, increasing nominal GDP but not real GDP.

3. The third kind of credit is speculative kind. It is spent on existing assets, real or financial, in the hope that these will rise in value. Because these assets exist, they can be purchased (and repurchased) without adding directly to GDP or straining the economy's capacity to produce new goods and services. Credit and asset prices then chase each other, even as consumer prices remain flat.

The author states that the lack of inflation suggests that growth in credit should be of the third kind (Speculative). The article considers the data as of 2013. Then if the author has eliminated the first kind of credit spending, then it means that China has failed to add much in terms of productive capacity. We ( Indians ) have not been known to spend credit the way China has. This leaves me the question: What kind of credit expenditure are our financial authorities doing? With inflation rising and growth slowing are we spending credit wastefully?

Also, credit expenditure expands the banks balance-sheets. The author mentions that Chinese financial authorities have accepted that the bank (especially mid-tier banks) balance-sheets are overstretched and they will carry out the necessary measures to encourage the flow of credit to 'real economy'.

Other than the above part there are certain statistics that have been mentioned about China that I find fascinating.

1. The working age population of China shrank by 2.44m in 2013, having already fallen by several million the year before. This is a demographic turning-point dubbed 'peak toil' ( interesting use of words ).

2. Last year China's output of services contributed 46% of GDP, finally overtaking the output of its industry which stood at 44%. In China Services are known as tertiary sector whereas agriculture and industry are considered primary and secondary respectively.