A General Theory of Markets

Ha! That's a pretty grandiose title for a post containing an insight many might call trivial. But, frankly, this had never occurred to me in any clarity until a few weeks ago, so I thought two or three people might be interested.

As Adam Smith pointed out, one should not expect the providers of goods and services to provide high quality because they're such nice people, but because they want our money. If you have a hot-dog stand and sell me a hot-dog I don't like, you can still keep my money, but I'm never going to come back. You thus have an incentive to sell me a hot-dog I actually like. That's the beauty of the market: It makes you want to offer something I enjoy even if you don't like me.

This implies that there is a set of circumstances under which markets are not going to work particularly well:

1. The provider of whatever is aiming at one-time, rather than repeat, business. Game theorists would say that there is no shadow of the future. The worst coffee I ever had was at the Expo, an event the typical customer is only going to visit once.

2. The consumer is in a bad position to evaluate the quality of what s/he's getting. There are at least two aspects to this:

a) Difficulty to relate effect to cause: If I don't like your hot-dog, well, that's due to its taste. Clear-cut case. On the contrary, if I have to vomit in the evening, this might be due to your hot-dog, the stuff I ate afterwards, some other thing...

b) Time-lag: If you pay for something, maybe repeatedly, before you're in a position to assess what you're actually getting. The perfect examples of this are insurances. You might pay and pay and pay your monthly premiums and the first time you file a claim they say, "Awww... nope!"

If any of the above applies, there may be a good case for government regulation, or even the government running the whole thing.

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