Economics vs Politics. Is free trade any good?

Economics experts fight over numerous of things, it’s the shame of the profession. The fact is that anything can be proven if you use the right econometric techniques, the right time-period and the right data set. So coherent theories are in fact in many ways more important than empirical evidence. Regardless of the dichotomy in economic debate there is at least one thing that would be in the economic bible and that is Free trade.

Free trade just means allowing products in and out of the country without imposing tariffs. The rationale for tariffs is that you want people to buy products that are made inside the country so that money stays in the country and develops the domestic industry. However from the consumer’s point of view, why should he/she care where the product is made? Since if even if the Japanese car industry thrives, they will export their great cars to your country and raise his/her standard of living. Whilst putting tariffs on their cars would either mean the consumer has to either accept a lower quality domestic car or accept to buy the Japanese car anyway at a higher cost, which either way reduces your standard of living because you either have an inferior product or because you have less dispensable income.

The part the Economics profession usually forgets is the politics aspect of tariffs. The reason you might not want to have free trade is if you believe instabilities between two countries will occur. You don’t want Japan to be providing all your cars for you because if they decide they no longer like you and want to go War with you, they can block all their products from coming into your country and helping you. Depending on how good the environment in the country is for setting up businesses, it is likely that either another country will provide the products or domestic industry will emerge, however if the Japanese industry was dominant chances are that your new supplier will not be as proficient, and depending on the product it could have devastating effects on the economy, such as if the product was food, that domestic workers tried to replace without enough expertise and end up selling toxic food.

So tariff’s are rationalized as a bargaining chip between governments, if you believe that relations with two countries are not likely to fall then then free trade is without doubt the route to go. This would probably be the US and Israel or Cyprus and Greece. So China making everything nowadays is not likely to be problematic, unless one believes that they might one day use it against other countries.

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Price gouging!

So my last post was about a critique of free markets so lets change direction. So what is price gouging? Its sort of like a limit on the profit margin you can charge, some states in the US have laws about how much margin you can make if there’s a disaster. So say a 10% margin limit means that if it cost you 100 dollars to come up with something you can’t sell it for more than 110. So why is this good? So you don’t get ripped off during a disaster, when your house is flying above your head, you probably don’t need some guy charging you 100 dollars for a bag of ice. On to the story:

A group of friends hear about a disaster hurricane event a couple of hundred miles away from where they are driving. So they decide to go buy packs of  ice for about a dollar each and drive down to the distressed area. They then stop in front of some residential neighbourhoods and start selling the packs for 12 dollars a pack. Lots of people run to them and start buying, then the police shows up and arrests them for price gouging. The people of the neighbourhood see this happening and they start clapping to support the police.

So what has price gouging accomplished? Its easy to think that these guys were being immoral and taking advantage of the people. But now lets use economics… there’s a finite amount of ice… so what’s the best way to give it around? The way to maximize utility, so give it to the people who need it most… so how do we do that? Some people want the ice to keep their baby formula the right temperature, others want it to keep their beer cold, others might want it for their medication.

We are actually fortunate that the price system comes pretty close to achieving maximum marginal utility, how does it do that? by maximizing profit, the seller’s profits are probably maximized by selling all the ice at the maximum price he can get away with. People who just want to keep their beer warm won’t be willing to pay so much as someone whose health could be on the line.  Would those friends even have showed up if the profit was capped at 10%? Would they spend hours driving to leave with a couple of dollars each?

The one disadvantage of the price system is that richer people will be negatively influencing the maximum marginal utility mechanism but in a given neighbourhood inequality probably isn’t very high and rich people might in fact still be inclined to think in terms of  long term “value for money”.

So all this not to say that all price gouging is bad, since there are many times were it is used to prevent fraudulent activity or times where everyone could have the same marginal utility.