Nova workboard

a blog from young economists at Nova SBE

Power to set prices – Everyone has it yet no one uses it – By Manuel Piedade #609

The general equilibrium framework works wonderfully well. The model ensures the best possible equilibrium between Demand and Supply for the Society as long as PRICES ARE NOT CONTROLLED. But this is always true? Not quite. Actually this Power results of a sort of Game Theory Framework if you think about it..

doesn’t use

 

 

uses

 

 

uses

 

Demand

Situation 1 – 0 ; 0

Situation 2 – E[4] ; -1

Situation 3 – -1 ; E[4] 

Situation 4 – 3 ; 3

doesn’t use

 

Supply

Situation 1 – A tantrum economy. Supply offers a good at the highest price possible because it suits them and can, technically, do it. Demand doesn’t budge to the price pressure and doesn’t buy the good, preferring scarcity or just trying to find an alternative somehow. It’s as if 2 children crossed their arms and faced opposite sides after arguing.

Situation 2 and 3 – These situations are sort of inverses of each other. Having one side exerting pressure will always lead to inefficiency, being it demand (monopsony situation) or supply (monopoly). In both these scenarios, the willingness to act by setting a price is only present in the powerful side which is anxious for an expected higher pay off since the other side has to subdue itself to his iron power and, basically, be explored. This exploration will then of course lead to an increasing feeling of “revolution” and prompt the exploited ones to try and use their own neglected power in the market, leading to a “tantrum” action (hence the “expected pay off”). They simply give up on the other side. E.g. if I’m being charged too high for gas, I’ll say “no” to my car and the expensive gas and ride a bike or use public transportation, even if it is less comfortable, until they drive down prices to a level where I’m willing to pay.

Situation 4 – This is the situation where the Almighty God, The Market, sets prices by Itself and no one has any power over them. The prices are set simply by the meeting of the Demand and the Supply sides, through the relative price ratio bridge. It is easily the most efficient situation, where in Equilibrium the Social Welfare is maximized. Note that, despite this being clearly the best case scenario, both sides have the power to change this if they wanted, although they won’t or shouldn’t because they would end up in the worst situation possible. Technically they could do this but logically they won’t. That is why only a “tantrum” could explain from this situation…

The reasons for a possible “tantrum” are much more intriguing as to what may lead anyone to move from the sweet spot 4. Food for thought as we do see some situations like nowadays.  

Advertisements

Author: studentnovasbe

Master student in Nova Sbe

Comments are closed.