Wednesday, November 11, 2015

Price Takers, Price Makers and Other Equilibrium Mysteries

Nick Rowe, in "Robots and the Core", was the beginning point of inspiration for this post. Even if I'm not quite sure how to relate these thoughts to his musings, I need to at least make sense of several pages of notes! First I referenced Wikipedia, for competitive equilibrium and general equilibrium. From the definition for competitive equilibrium (also called Walrasian equilibrium):
Competitive equilibrium is the traditional concept of economic equilibrium, appropriate for the analysis of commodity markets with flexible prices and many traders, and serving as the benchmark of efficiency in economic analysis. It relies crucially on the assumption of a competitive environment where each trader decides on a quantity that is so small compared to the total quantity traded in the market that their individual transactions have no effect on the prices. 
Given the fact that Nick Rowe was asking a general equilibrium question, some Wikipedia notes for general equilibrum theory:
...attempts to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall (or "general") equilibrium. 
One more quote would be helpful, from the opening of a paper provided to Nick by a commenter, "Markets With a Continuum of Traders" by Robert J. Aumann:
It is suggested that the most natural mathematical model for a market with "perfect competition" is one in which there is a continuum of traders (like the continuum of points on a line). It is shown that the core of such a market coincides with the set of its "equilibrium allocation", i.e. allocations which constitute a competitive equilibrium.
In earlier posts I spoke of a continuum for potential time use value. Now, imagine continuum in terms of overall wealth generation. The initial component consists of price takers in competitive equilibrium, which generates further settings for asset and income formation. This tradable goods component of competitive equilibrium is where - in the U.S. - one "votes" for product preferences through the use of dollars.

However, in general equilibrium, both the price taker dynamic and voting mechanism start to break down, as price makers isolate multiple characteristics of time based knowledge use to their advantage. Since time based aggregates are fixed in relation to (other) resource aggregates and their representative monetary component, voluntary services coordination may become limited to subsets of equilibrium (Little about prison confinement is voluntary). While price making is prevalent in services formation, it can also be problematic when employment capacity for technological gains is captured by special interests - such as the auto maintenance and repair of recent decades.

Imagine general equilibrium as two parallel continuum. On the one side, tradable goods wealth and that of asset formation. On the other, exists services formation, employment and knowledge use. Crucially, non tradable sector representation extends across both of these continuum. Hence asset formation is somewhat complicated by the fact it represents income wealth from both tradable and non tradable sectors.

An important consideration regarding price takers versus price makers, is what Nick Rowe states as an obvious preference if new technology "reduces worker's wages and capitalists' rate of profit":
If it reduces both workers' wages and capitalists' rate of profit, why would workers and capitalists ever adopt that new technology?
Nick just beautifully illustrated the ongoing tension between tradable sectors and non tradable sectors in general equilibrium - indeed, the very struggle that local corporations would need to overcome by allowing citizens to innovate both infrastructure and asset formation. The price taking mechanism of time arbitrage would allow comparable price structures for an alternative equilibrium, which would benefit from a broader definition of good deflation than is now possible.

Price making occurs when wealth capture leads to means (let me count the ways) for resisting innovation. The price takers of tradable sectors became flexible and "escaped" local conditions in recent centuries, in part due to necessity. New technology was adopted not necessarily because of better wages and profits, but because producers were increasingly faced with global competition in tradable goods. Since better technology meant more (lower cost) product in aggregate, profit was achieved by maximizing a marketplace, instead of imposing demands on a naturally limited marketplace.

Still, non tradable sectors did not always have the same options for innovation which exist today. The immense gains of technology and organizational capacity, could potentially bring good deflation to non tradable sectors. But centuries of price maker mechanisms stand in the way. Why would the producers for what are essentially "captured" markets, want to reduce their profits by innovating in ways which mean fewer rewards?*

Again - as Nick Rowe asked - why adopt new technology if it means less profit or lower wages? While tradable sector price takers contribute to good deflation through innovation, price makers of non tradable sectors create bad (internal) inflation through regional wealth capture. Worse, even as housing and services contribute to internal inflation, they can just as easily suffer bad deflation (asset depreciation and services "austerity"), if and when monetary policy overreacts by tightening monetary conditions.

Another consideration in Rowe's post was land. Both income and land in highly sought after cities benefit from international wealth flows. There is a growing argument for equilibrium alignment, which consists of moving more people to more prosperous areas. However, what is most needed for greater growth capacity, is greater dispersal of knowledge use. Presently, limits in this regard are diminishing total resource capacity.

This is why new wealth needs to be generated outside of primary equilibrium. Even though more housing could be built in highly desired cities, knowledge wealth cannot just "open the floodgates" to accommodate an equilibrium which in many respects relies on international wealth flows. Indeed, land is intricately tied with the international wealth of primary equilibrium. Land aggregates are mostly difficult to access, insofar as knowledge use is also difficult to access.

General equilibrium, with its multidimensional arena of goods and services, includes a still growing price maker environment in search of greater profit. But a long trail of preexisting claims on international wealth, accounts for the fact that some now call for a return to a gold standard. Instead of a gold standard, give fiat monetary formation and non tradable sectors a realistic outlet for alternative equilibrium, which includes an innovative price taker framework. For knowledge use systems, aggregate time value provides a much needed price taker context for service formation. In short, I long for the day when time value can be exposed to competitive equilibrium.

The fact that non tradable sectors chose not to innovate wouldn't be so problematic...except these sectors were structured to rely on the monetary redistribution of traditional manufacture. Over time, tradable sectors generated less wealth for the needs of non tradable sectors because they did not cost as much to produce in aggregate! Hence the upside down world of monetary policy, until some balance finally takes place between the two.

There is only so much room for a general equilibrium which prefers the (internal) inflationary practice of price making for greater profits, all the while still dependent on the good deflationary wealth of the price takers. For all the accolades that free markets deserve, nations forget the degree to which broader markets are the result of "escaped" (global) competition, as opposed to the "contained" (local) competition, which is more inclined to generate wealth by claiming local "hostages". In other words, by actively working against free markets. Supply side? Heal thyself. If this post includes something which offends everyone (and there's a good chance it does), please accept my apologies. And I must confess that sorting through all of this was a pleasant challenge.

*Granted, some tradable goods - especially those with large knowledge use components - are willing to take a page from the price making of non tradable sectors, by seeking more ways to limit duplication. Hence the dubious nature of some trade agreements which are more about creating limits to product formation, rather than aggregate gains in product formation.

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