Saturday, April 18, 2015

Free-riders And Minimum Wages - Both Or Neither Are Problems

Is this a better market?  Gabe (the gay) is paying Alex (the atheist) for a cake.  Isaac, who's wondering what to do with his life, is observing this exchange take place.  Because neither Alex nor Isaac are omniscient... they can't see how much Gabe values the cake.  All they can see is how much he pays for the cake.  Only Gabe knows that he values the cake a lot more than he's paying for it.

By sharing the wrong information, Gabe increases the chances that Isaac will do the wrong thing (not supply cakes).  Garbage in, Garbage out.

Is this a better market?  In this scenario Gabe is paying a lot more than he values the cake.  Gabe is lying again.  This increases the chances that Issac will do the wrong thing (supply cakes).  Garbage in, Garbage out.

X < Y = free-rider problem
X > Y = forced-rider problem

A minimum wage is an example of the forced-rider problem.

Let's think about water.  Is Isaac always going to value water equally?

In the Sahara... Isaac is suffering from a severe shortage of water (dehydration).  In Niagara... Isaac is suffering from a severe surplus of water (drowning).  Therefore, he values water very differently in these two very different circumstances...

Y1 > Y2

Whether it's water, cake, labor, a Netflix show or national defense... what we pay should accurately communicate our valuations.  This increases the chances that other people will do the right things.  Otherwise, we all end up with more of what we want less and less of what we want more.

Accurate information = treasure in, treasure out
Inaccurate information = garbage in, garbage out

Coincidentally, Alex Tabarrok recently shared some relevant thoughts in his review (Is Capitalism Making Us Stupid?) of Joseph Heath's new book Enlightenment 2.0...
Advertising may sometimes trick us into buying products that don’t serve our interests, but the more we are tricked the greater the incentive to become informed. In the market, we can act on information to improve our purchasing decisions. In politics, it doesn’t pay to be informed because as individuals we have nearly zero power to improve collective decisions. In the market, information is power. In politics, information is impotent.
Heath’s conservatism makes him unwilling to suggest radical ideas. But big problems often need radical solutions. Voting, for example, reduces the cost of ignorance and irrationality. Raise the cost and people become more informed and rational. When pollsters ask Democrats and Republicans factual questions such as did inflation fall during Reagan’s presidency or were weapons of mass destruction found in Iraq, they answer in a highly partisan manner. But partisan bias greatly diminishes when voters are told that they will be paid if they answer correctly. Betting is a more reliable guarantor of objectivity than voting. Or, as I once wrote, “A bet is a tax on bullshit.”

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