Information and Markets Chapter 9. Free Persimmons!

Information and MarketsChapter 9

Free Persimmons!

Why on Earth Would an Economist Give Away

Free Persimmons? We got a bumper crop on our

tree! Neighbors got a bumper crop,

too Can’t sell at farmers’ market

Not certified organicNot sure how to do itCosts money, right?

Can’t sell around townWho has time (or a cart)?Probably illegal; traceabilityHealth regulations, etc.

Or Are They Really Free?

• No economist thinks people give gifts for free• Gift-giving in poor villages

– Pervasive (has to be on our survey forms!)– Cements social ties that can help out when the

crop fails, kids get sick, etc.– Reciprocation as (informal) insurance

• Will I get a chili pepper this quarter?

What’s a Market?mar·ket /ˈmärkit /

An open place or a covered building where buyers and sellers convene for the sale of goods (Dictionary.com)

A meeting together of people for the purpose of trade… a public place where a market is held (Merriam Webster)

A regular gathering of people for the purchase and sale of provisions, livestock, and other commodities (Oxford)

Where does ebay fit in?

There’s a farmers’ market in my town, but that didn’t help me with my persimmons…

Images from a Tigray (Ethiopia) Market

Markets Are Where

• Buyers and sellers “discover” one another– It doesn’t have to be a farmers’ market

– ebay or Safeway

• Price discovery happens• More broadly: An infrastructure and set of

institutions that facilitate the transfer of property rights from one person to another – Simple for a persimmon or potato

– More complicated for real estate, a loan, or insurance policy

Yet Millions of Smallholders Opt Out of Markets—Why?

• “The institutional and physical infrastructure necessary to ensure broad-based, low-cost access to competitive, well-functioning markets” requires “significant investment, typically by the public sector, paid for out of tax revenues or aid flows.

• One thus has to get institutions and endowments, as well as prices, ‘‘right” in order to induce market-based development.

Chris Barrett, Food Policy 33 (2008) 299–317

Welfare Basics: Producer Surplus

• Producer surplus is given by the area between price and the supply curve– Our measure

of producer welfare

Welfare Basics: Consumer Surplus

• Consumer surplus is given by the area between the demand curve and price– Our measure

of consumer welfare

Price DiscoveryThe intersection of supply and demand give the equilibrium price and quantity for a nontradable in the village

Everything in ZSv and ZDv is reflected in the village price (see boxes: Hayek’s “All in One Price” and—for households—”Estimating the Shadow Price of Corn”)

Nontradable Village Staple

Sv(ZSv)

QuantityQv

Price

pve

Dv(ZDv)

a

b

Trade “Decouples” Local Supply from Demand for Tradables

• At regional price pr, the village supplies QSv and demands QDv

• The difference is village exports• Consumers lose “Consumer Surplus” c+d• …but producers gain more (“Producer Surplus” = c+d+e)• Now price discovery is outside the village (It depends on ZS and ZD, NOT ZSv and ZDv) !

Village Staple Market

Sv(ZSv)

QuantityQDv

S(P,ZS)

Quantity

Price

pr

D(P,ZD)

QSv

pr

Dv(ZDv)

c e

Price

Regional Staple Market

Qr

Village “Exports”

dpve


Sv

QuantityQv

Price

Dv

a

b

Bad Harvest in a Village Cut Off From Markets

pve


Sv

Quantity

Price

Pve’

Dv

Bad Harvest in a Village Cut Off From Markets

Sv’

Qv’

ab


Sv(ZSv)

QuantityQv

S(P,ZS)

Quantity

Price

pr

D(P,ZD)

Qr

pr

Dv(ZDv)

c d

Price


Qr

Bad Harvest in a Village Integrated with Markets

pve

S(P,ZS)

Quantity

Price

pr

D(P,ZD)

Qv

pv=pr

Dv

Price

Qr

Bad Harvest in a Village Integrated with Markets

Village Staple Market Regional Staple MarketVillage Staple Market

Sv

Quantity

Price

Pv’

Dv

Sv’

Qv’

a

a

a


Sv

QuantityQv

S(P,ZS)

Quantity

Price

pr

D(P,ZD)

Qr

pr

Dv

c d

Price


What’s In the Regional Price? (Let Z’s Change)

Qr

pve

Sv

QuantityQv

S(P,ZS)

Quantity

Price

pr

D(P,ZD)

Dv

Price

S(P,ZS’)

pv=pr’

Qr

A Bumper Crop Somewhere in the Region

Village Staple Market Regional Staple Market

Sv

Quantity

S(P,ZS)

Quantity

Price

pr

D(P,ZD)

Qv

pv=pr

Dv

Price

Qr

Income Growth Somewhere in the Region


Sv

QuantityQv

S(P,ZS)

Quantity

Price

pr

Dv

Price

D(P,ZD)

D(P,ZD’)

pv=pr’

Income Growth Somewhere in the Region


Within Countries, Transaction Costs Create a “Deadweight Loss” and Turn Tradables into

Nontradables

• The isolated village incurs consumer transaction costs tc per unit purchased and producer transaction costs tp per unit sold– Consumers must pay pr(1+ tc)

– Producers get pr (1- tp)

• If the village equilibrium price pe falls within this “price band,” both buyers and sellers are better off not transacting with outside markets, given transaction costs– …so the economy will be in autarky– …with deadweight losses (like what countries suffer with import

tariffs)

Sv

Quantity

S(P,ZS)

Quantity

Price

pr

D(P,ZD)

Qv

pv=pr

Dv

Price

Qr


Deadweight Loss from Isolation

Sv

QuantityQv

S

Quantity

Price

pr

D

Qr

pr

Dv

A B

Price

Transaction cost tpr

(1-t)pr

Deadweight Loss from Isolation

Sales to Region


Qr

pve

George Akerlof’s Market for Lemons• Assume that:

– (1) Cars vary in quality, distributed uniformly on the interval [0,1]• Average quality = 1/2

– (2) Sellers value cars identically to the car’s quality, i.e. $q is as good as a car of quality q (this just makes our example simpler)

– (3) Buyers value cars based on quality, but cars are systematically worth more to buyers than sellers. In particular, a car of quality q is worth $3/2q to a buyer. (I just paid a buyers fee at auction!)

– (4) Only sellers know the quality of their car (asymmetric information)

• For a car of quality q, both buyer and seller can be made better off by trading the car at a price somewhere between q and 3/2q

• Buyers don’t know quality; they assume they’re getting a random draw (E(q)=1/2))

• The most they would pay is their expected utility of a car: 3/2 * 1/2p = 3/4p– But this is < p for all p>0, so the seller won’t take it!

• The market fails; only the worst cars (“lemons”) are left.

Imperfect Information Causes High Transaction Costs

• George Akerlof: The Market for Lemons– Asymmetric information can kill markets (see “Selling

Green Beans to Europe” box• Poor roads and communications cut the buyer and

seller off off from information about each other– where to sell (or buy)– when to sell (or buy)– how to ensure quality– the price you’ll get (or pay)

• Markets fail when it’s too costly to solve the information problem

The Fundamental Problem of High Transaction Costs in Poor Economies

• With high transaction costs different producers face different prices– …and thus produce at different MCs

• The same thing happens to consumers– …they consume at different marginal rates of substitution

• Efficiency could be increased by reducing or eliminating transaction costs, so that trade can equalize prices across markets (see “Saving Fish with Cell Phones” box)

• Market failure happens when people can’t get together to make efficiency-enhancing trades– Extreme transaction costs: Civil war (see “Famine and Missing

Markets in Tigray”) – Imperfect information causes the First Theorem of Welfare

Economics to fail (Greenwald-Stiglitz Thm.)

Another Market Failure: Externalities• Classic case where market doesn’t happen• Agents do not take account of the social costs of

their actions– only the private costs and benefits– Climate Change: Making a market for CO2

The socially optimal quantity is where the social marginal cost equals marginal benefit (demand)

The private optimum is where the private marginal cost equals marginal benefit

The (vertical) difference represents the external costs

On Globalization (and Market Integration)

“This has created many new opportunities, but also new questions regarding the roles, functions and core capacities of the various key players. Deep-rooted principles and paradigms have been cut down in a short period. It is sometimes like mixing an Italian basketball team with Nigerian soccer players, and trying to play in a volleyball tournament. The new situation raises many questions about how the game is played, and who are the winners and losers.” (KIT, 2006)

Information and Markets Chapter 9. Free Persimmons!

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