Unexpected market instability!!!
November 26th, 2009 | Published in Economics idea | 2 Comments
I have been describing a very simple Apple Pie world starting with this post.
Even simple markets have problems
I can’t figure out how a stable exchange price for apple pies and ingredients could be established in Apple Pie World.
Suppose that it takes two farmers to produce the ingredients that one baker is able to use making pies working full time. It makes sense that 2/3 of the population should be farmers, 1/3 should be bakers. The bakers should give 2/3 of their pies to the farmers for the ingredients keeping the final third for themselves.
This is the full employment situation we would want. Bakers and farmers get the same number of apple pies so there is no incentive to switch professions.
The trouble is I can’t think of a good mechanism to get to this equilibrium if the number of bakers and farmers is not properly balanced. At least I can’t think of a good mechanism without adding complexity to the model.
Too many farmers
If there are too many farmers at a given point in time, there are going to be ingredients that can’t be used. Some farmer isn’t going to be able to trade his crops for apple pies. Which farmer will it be? The farmers will trip over each other lowering their price trying to make sure they aren’t left without their coveted apple pie. Even a small surplus of farmers would drive the price of the ingredients (in pies) very low.
The same problem would happen to bakers if there were too many bakers.
Stampedes
The result of crazy price swings would be stampedes back and forth creating surpluses and then deficits of farmers. The situation is inherently unstable.
November 27th, 2009 at 12:15 am (#)
I know you’re trying to keep it simple, but I’ve got two more complexities: effort and quality. Can we assume that bakers can produce 50% more pies if they work 50% more hours? This would mess up the 1/3, 2/3 split. We can probably leave quality aside for now, but what if some pies were tastier than others? They might have higher value, or at least be sure to get sold.
Regarding the imbalances, I’m not sure why you immediately assume there will be stampedes and farmers “tripping over each other” to lower prices. The problem would be that no farmer would want to be the last one standing with no one to sell to. There’s a risk. But why would they all cut their prices drastically if the risk was low? Also, the excess production might be spread out over all the farmers. That is, a 5% surplus might mean a 5% reduction to all farmers rather that 5% of the farmers getting zero.
Two mechanisms to fix the surplus would be overtime or flexible workers. If bakers could work overtime (or farmers not work full years), the system would balance. Alternatively, if some portion of the population could both farm and bake, perhaps less efficiently, they could profit from the imbalances.
November 30th, 2009 at 8:41 pm (#)
Eric.
Good points. The quality issue is perhaps an unavoidable issue. If some people are better at baking, their pies would likely taste better.
The problem of matching supply to demand is tricky. I am beginning to think that it all comes down to how markets are constructed. I’m going to have to think about it some more.