From: lydick@SOL1.GPS.CALTECH.EDU (Speaker-to-Minerals)
Newsgroups: alt.callahans
Subject: Re: In defense of greed
Date: 8 Nov 1992 09:01:56 GMT
Organization: HST Wide Field/Planetary Camera
Distribution: world
Reply-To: lydick@SOL1.GPS.CALTECH.EDU
NNTP-Posting-Host: sol1.gps.caltech.edu

In article <1992Nov8.032042.6217@midway.uchicago.edu>, eeb1@quads.uchicago.edu (e elizabeth bartley) writes:
>Greed nowadays has a bum rep.

[about 80 lines of justification for that statement, with which I mostly agree,
deleted]

StM adds some caveats.  "In fact, it's an important theorem in microeconomics
that, given certain conditions on the markets, a free market will yield Pareto
optimal results.  For the non-economist types out there, a result is Pareto
optimal if, and only if, it's impossible to make anybody better off without
making someone else worse off.  However, the conditions the markets must meet
are important;  as Beth's already pointed out, fraudulent trades may prevent
optimal solutions, but there are other conditions as well.  The most important
(well, to be honest, the ones I still remember offhand after having been away
from the study of microeconomics for over a decade now) are:
1)  No externalities.  This is pretty much equivalent to a requirement that
    there be a market for EVERYTHING.  An example of an externality is smog:
    If a person drives his car in a smoggy area, he's increasing the amount of
    smog there.  That extra smog injures everyone; it doesn't hurt any
    particular person very much, but it hurts a LOT of people.  But the
    (greedy) individual driver takes into account only the effects of the smog
    he produces on himself.  As a result, he drives if the benefits to himself
    from driving are greater than the harm to himself arising from the extra
    smog he's creating.  The injuries to everyone else are not a factor.  So
    he drives more than is socially optimal.  *IF* there were a market in
    smog, then either he would have to buy the right to produce smog from his
    fellow citizens, or his fellow citizens would be able to pay him not to
    drive so much.  In either case, he'd almost certainly drive somewhat less.
    But there IS no market.  Why?  Well, for one thing, the cost of having the
    driver negotiate with all the other citizens would be prohibitive which
    brings us to
2)  No transaction costs.  Transactions costs can be of many sorts.  There's
    the price of negotiating in the example above;  Beth mentioned Michael
    Milken in her post.  His commissions are transaction costs.  For every
    trade, he gets some percentage of the amount of money that is exchanged. 
    Not only is this a transaction cost, but it gives a broker an incentive to
    "thrash" an account:  To engage in trades that aren't really worth the
    costs to his client, but which still increase his commissions.  Please note
    that this thrashing doesn't even need to be intentional.  But even without
    the thrashing, the broker imposes a transaction cost, which violates
    condition 2.  You may argue that the broker is providing a real service by
    matching buyers and sellers.  He is, but the third condition I can remember
    offhand is
3)  Perfect and complete information.  Every participant in the market must
    know the actual value to himself of the goods and services being traded,
    and must know what the going price for these goods and services is.  Please
    note that this condition rules out the possibility of fraud, but it *ALSO*
    means that the matchmaking Milken et. al. did is unnecessary.
OK, so if the above conditions are met, then a greed-driven free market will
achieve a Pareto optimal solution.  The next question is, in real markets, are
the conditions met?  The answer is almost always "No."  We can ask a slightly
weaker question, which is "How close are the conditions to acually being met in
the real world?"  The answer to this one is frequently, "Very close."  Which
leads us to a third question, "If the conditions aren't met, how does this
affect the optimality of the market solution?"  The answer to this one is
generally  "I don't know."  Certainly one can no longer prove the optimality of
the market solution, but there's a chance it might still be optimal, especially
given the costs involved in implementing a non-market solution.

And finally there's the question of interpersonal comparisons of utility. 
Suppose Frankie and Johnny are splitting a pie.  Pareto optimality simply means
they don't waste any of the pie.  Two possible divisions are:
	A)  Frankie gets the whole pie; and
	B)  They each get half of the pie.
Both of these are Pareto optimal.  However, the first would generally be
considered inequitable.  Economics can deal only with deciding things like
Pareto optimality.  On the matter of equity in solutions, it must remain mute.
That's a matter for philosophy.

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