Business and Society Economics

What is economics for? Part 2

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My last blog claimed that equilibrium economics is a fig-leaf for the rich and powerful – because it is a justification for preserving the status quo. But it is more than that, because the conditions required for reaching any such equilibrium (the point at which prices of goods and services have adjusted so that everyone wishing to buy is partnered by someone wishing to sell) are exactly those that are likely to allow those with existing wealth to become richer.

In the theory, this can’t happen, because in equilibrium everybody pays everybody else exactly what is needed for them to provide the good or service desired – no more and no less. Extending this idea a little further, it’s still reasonable that in an economy that is developing new goods and services we might allow a firm to charge us a bit extra on the promise of working on some new and better products. But what if we knew the firm were wanting these extra funds to produce misleading advertising, to bribe officials to cover up evidence of pollution, or to cover the costs of a temporary loss while they push a competitor out of business? We would surely then refuse to pay the prices demanded.

But the reality is we cannot know exactly what is the right price to pay for any good that ensures that the firm gets exactly the right money value in return. Even if we considered the possibility, life is too short for each one of us to be so vigilant. So at least some of the time firms can earn more than they need to do what we want them to do. (Sometimes they can earn less, but firms that make a habit of this will soon go out of business!) As far as economists consider this problem – and since it cannot occur in their framework theory, they tend not to – they consider it a reward and incentive for innovation and therefore really as some sort of additional consumption for the firm. As a result standard economics has no further interest in what happens. It’s just the luck of the draw, and over time each firm and individual has an equal chance of losing and gaining these rewards.

But this is nonsense – firms are not ‘consumers’. When firms’ prices exceed their costs, the surplus money is available for them to use to further the firm’s prime activity – maximising money revenue while minimising money costs. Since by definition a surplus has been earned against consumer choices these activities are very unlikely to be in the furtherance of those choices. (In fact the only way firms could really do this is simply to pay the money back to purchasers – but this would require an assumption that consumers would repay the favour when they earned a surplus.) In fact what firms generally do with their surpluses is to enhance their chances of earning a surplus on subsequent sales.

Within the confines of the market itself, they can do this through the price mechanism, by setting prices lower than the cost of producing goods. In the short run the firm makes a loss, but whereas other firms will go bankrupt, the surplus can act as a cushion. Once the other firms have been driven out of the market, competition is reduced and increased market power leads to additional surpluses. But contrary to most economic theory, markets are not free-standing, but are embedded in the social fabric. Economic power can also be translated into social and political power and back again. A monetary surplus can be used to purchase advertising using persuasive power to over-ride market signals, to lobby politicians to change market rules or use legal means to suppress adverse information about your product or production methods.

In the theory of economics, the extent to which markets are monitored and regulated affects the chances of equilibrium being reached. If equilibrium is to believed to be the point of maximum advantage, then it is obvious that equilibrium economists will be in favour of removing this monitoring and regulation. But, in the actual world of markets that rarely (if at all) reach equilibrium and are embedded in a complex web of social connections, removal of this monitoring amplifies the consequences of the absence of the theoretical equilibrium.

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