Scarcity

I’m reading The Undercover Economist by Tim Harford, as I mentioned over at Eric’s Grumbles yesterday. The interesting thing, and Harford makes a compelling case for it, is that scarcity is the driving factor in all markets. If the cost of a product is high, yet it seems like the cost to produce it is low, look for the scarcity in the market, whether natural or artificial. The more scarcity, the higher the price that the consumer will pay, regardless of the production cost.

For example, suppose there were some sort of boundary around a city that would prevent the city from growing. As the number of people seeking to rent/own property in the city increased, the scarcity of the land would also, because the city couldn’t acquire more land. The landlord may have bought the land for $1,000 and be able to sell it for $10,000, for example, because there are more people who want the land than there are pieces of land to sell. In the real world, London has a so-called Green Belt around the entire city that acts as a boundary to the city’s growth. It also has the highest commercial and residential rents in the world, higher than Tokyo, San Francisco, Hong Kong and Manhattan, even though all four of those cities have natural barriers causing scarcity.

Scarcity of a resource, whether that resource is buyers or sellers, drives the cost. But so does the marginal value. That is, if it costs more to acquire the resource than it would cost to create it yourself, then buying the resource is not worthwhile. The example used in the book is farmland. If there is a lot of undeveloped land and only a few farmers, the rent will be low. The resource is not scarce and the marginal value is very low. If there is a lot of farmers and no undeveloped land, the rent will be high. The resource scarcity is now reversed and the marginal value is high.

Why bring all of this up? Well, in the debate over whether Microsoft is a monopoly and whether that is good or bad, I mentioned scarcity and was asked what that had to do with anything since we clearly don’t have a scarcity of operating systems. Since there are a multitude of operating systems and, comparatively, not that many buyers, the buyers should be able to drive the price down. They are scarce, not the resource. However, Microsoft and the OEM’s (Dell, Compaq, etc.) created artificial scarcity, so that there were fewer operating system choices for the same number of customers. At this point I’m not arguing whether this is good or bad. Just pointing out why the operating system market is artificial.

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  • http://belowbeltway.blogspot.com Doug

    Okay, I understand what you’re saying, I guess I just don’t know why it matters. Also, I am generally suspicious of arguments about issues like this because it inevitably seems to lend intellectual support to those who would argue that the state needs to intervene in the market to correct some imbalance.

    Besides, as I said in my last comment to the monopoly post, a good bit of Microsoft’s success can be attributed as much to the sometimes inept decisions made by its competitors as to anything nefarious coming out of Redmond, Washington.

  • http://thelibertypapers.org/2005/11/21/who-is-eric/ Eric

    Please note, I have never advocated government intervention. In fact, I would argue that government regulation and intervention helped to create artificial scarcity in the operating system market of the mid 90’s.

    Doug, you’ve argued that what matters is the ends, not the means. I don’t happen to agree with that. However, for consistency’s sake, if you think that the ends is what matters, you should see that collusion that creates artificial scarcity is bad since it results in ends that are bad for the consumer. I was, to tell you the truth, very surprised when you made an argument that the means don’t matter, only the ends. That is the consequentialist argument that leads to government regulation of the market.

  • http://belowbeltway.blogspot.com Doug

    I’ve had second thoughts about the breadth of that comment I made earlier today. Obviously, the means do matter — you can’t use immoral means to achieve good end, for example. In retrospect, I should have made my point a little clearer than I did.

    I think the problem is trying to apply judgments to market outcomes to begin with. Who are you or I to say that we know that things would have turned out a different way if Microsoft hadn’t insisted on restrictive contracts with PC makers, or that consumers would be better off ? The fact is, we don’t know and I think its dangerous to say that its even possible to know something like that because its the same thing that people who believe in a planned economy say.

    To clarify the point, a particular market outcome — be it Microsoft’s dominance in the OS market, or the fact that Ford and GM are losing market share to Honda and Toyota — is neither good nor bad, it just is. The market is merely the reflection of the choices and decisions made by countless numbers of consumers and business people on a daily basis. So long as nobody’s rights are being violated (and I would submit that nothing Microsoft has done constitutes a violation of or threat to anyones life, liberty or property) there is no such thing as the “right” outcome when it comes to the operation of a free market.

  • http://belowbeltway.blogspot.com Doug

    Eric,

    I didn’t mean to imply that you were advocating government regulation. I just think there’s a danger when people who believe in free markets start conceding, even in some small respect, the attacks on the free market made by collectivists.

  • http://thelibertypapers.org/2005/11/21/who-is-eric/ Eric

    Thanks for that clarification Doug, I was wondering if you had suddenly changed allegiance on us!

    Here’s my thinking. I agree that a company gaining or losing market share should be viewed as a natural part of the market that “just is” and is neither inherently good or bad. However, when a company gains market share to the point that it now effectively controls the market, we are in the position where an elite is making the decisions about what is best for the market, rather than market forces making that decision. For example, once Microsoft won the browser wars, they no longer responded to market forces desiring new features and functionality in their browser. This is not, in and of itself, bad. The market can correct this. The rise of Firefox is, in fact, a market response to that issue. Where it becomes a bad thing is when Microsoft then makes deliberate choices to cripple the other guy’s ability to compete and does so in a way that is hidden from view. See some of my comments on Brad’s blog in his thread about Hotmail for what I mean.

    So, this still isn’t necessarily bad, in general practice. It’s just part of being competitive. But, think of it as cheating in sports. Let’s say throwing a spitball in baseball. Which is a hidden thing that detracts from the batter’s ability to hit the ball. Normally a referee would prevent this. What happens, though, when the referee is beholden to the pitcher? Or, in this case, one of the major content portals on the Internet (MSN) has made systemic changes that prevent anything other than a MS browser from displaying the page properly and done so in a way that is hidden from the view of the market. This is the actual outcome of a monopoly market. It isn’t that things are good or bad, but rather that your choice is impacted.

    Oh, and monopolies do impact Life, Liberty and Property. Specifically liberty and property. You argue that you can always choose not to buy from Microsoft. I argue that you no longer have that choice. And that PC’s are such an integral part of US culture and economy that it is impacting your Liberty. Monopolies never price things in response to market demand (i.e. scarcity) because the monopoly now controls scarcity. The monopoly artificially manipulates scarcity to increase their profit. Since money is a representation of wealth and property, it seems clear to me that artificial scarcity leads to an infringement on my property. If I have a choice, then you trying to maximize your profits doesn’t do that. If I don’t have a choice, it does.

    The real answer here is to get rid of the horrendous regulatory and legal environment that aids and abets the creation of these kinds of monopolies. Not to create more regulation to try and undo them.

  • http://thelibertypapers.org/2005/11/21/who-is-eric/ Eric

    P.S. The creation of the Microsoft monopoly was aided, both directly and indirectly, by the government. Just because it isn’t visible doesn’t mean it isn’t there. When the entire Federal government chooses to switch from Lotus to Microsoft, it impacts the viability of the market. And leaves Microsoft awash in tax money that they can then use to strengthen their market position. When the federal government enacts regulations that are difficult for smaller competitors to adhere to, it enables larger companies to monopolize the market. There is a reason that IBM, Microsoft, Oracle, GM, Ford and all the rest don’t oppose government regulation.

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  • http://belowbeltway.blogspot.com/ Doug

    Eric,

    Unfortunately, government involvement in the market is a fact of life today and there really isn’t much we can do about it.

    If a monopoly exists because the government created it, then it cannot be said to be in accord with free market principles. As I’ve said before, there are several examples of this government-created or protected monopoly: the Postal Service, AT&T before 1984, the local telephone companies until the late 90s, electric and gas utilities (though some states now allow competition in this area), and cable television.

    However, I am not aware of any steps that the government has taken to protect Microsoft’s monopoly or impose legal barriers preventing competitors from entering its markets. If all you’re talking about is the fact that the government decided to stop buying Lotus and start buying MS Office, I don’t think that constitute an improper creation of monopoly power. Local police departments buy alot of Ford Crown Victoria’s for use as cruisers; that doesn’t mean they’re helping give Ford a monopoly in the police cruiser market.

  • http://thelibertypapers.org/2005/11/21/who-is-eric/ Eric

    Doug “Unfortunately, government involvement in the market is a fact of life today and there really isn’t much we can do about it.”

    That doesn’t mean we should accept the outcomes as being in accord with a free market OR consider those who manipulate the market to profit from such things as being good businessmen. In actual fact, in the opinion of someone who works for a large company, we benefit dramatically from government regulation on a daily basis. Government regulation creates a significant barrier to new competition. Companies such as Microsoft, IBM, GM, Shell (and the rest of the Fortune 500) lobby very effectively for laws and regulations that are anti-competitive. To then turn around and insist that these companies aren’t creating government assisted monopolies seems pretty off target to me.

    I recognize that it is a current fact of life that the government intrudes into the market place in ways that disrupt and distort the market. That doesn’t mean I think it’s okay. Nor does it mean that I think well of anyone who uses that to create a monopoly.