“Markets” Are Truly Hard to Understand

Today, the Republicans will vote to repeal and replace Obamacare.  Yesterday, Aetna announced they were pulling out of the Virginia “Obamacare Market”.  Today, the CEO of the NASDAQ released a statement on how they would like to see markets reformed.

I hear a lot of people speak about markets but few of them truly understand what a market is.  That includes people in authoritative positions.

After doing what I did for so long, I understand markets viscerally.  I love chatting with people like Leo Melamed about markets.  It’s fun because we can talk about market structure in a much deeper way.  You don’t have to explain how a market works.

One of the nice things about getting my MBA at Chicago Booth was that I was able to put rigorous academic theory behind my visceral gut feel.  It doesn’t make you a better trade, market-maker or anything like that.  But, when confronted with things you understand why they won’t work, or will work faster.

The free market system is the best allocator of resources.  Period.  It’s ingrained in human DNA.  Markets have been with us for as long as we have inhabited earth.  You don’t even need cash or a government to operate a market.   Read this piece on The Economics of a POW Camp.  It should open your eyes.  I have spoken with POWs from that exact camp and they confirmed what the piece says.

People have lost faith in the free market system.  They think it’s rigged.  It’s not rigged.  The problem is either in the structure or the constraints put on markets that don’t allow them to work.  Obamacare is a perfect example.  It was never designed right in the first place.  What was the result?  Skyrocketing premiums with less care.

If perfect competition exists and no limits constrain a market, the end result is always lower prices with more quantity delivered.  Always.  Obviously, we can’t have “exact” perfect competition but we can try to get close.  The closer we get, the more efficient the market is.  The closer we get, the better it is for everyone.

What are the principles of good market design?

  • Freedom of entry and exit
  • Freedom of choice
  • No price floors or price ceilings
  • Price transparency
  • A mechanism to make sure every player performs on their  bid/ask/trade

That’s pretty much it.  People make it much more difficult that it has to be.

 

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  • awaldstein

    Markets are amazingly difficult as it is the human factor that makes them work or not and that is not programmable.

  • Dan Kunze

    that POW camp piece is amazing.

    • Pointsandfigures

      It really is. That says it all about how markets are core to the human experience on earth and how centralized authorities screw them up. People will always try to maximize their own personal gain from trade. It’s not that they are trying to “get up” on someone else. When you think about a POW camp, you are thinking about a place with truly constrained resources and a lot of the participants getting the same resources to bargain with. But, because of personal preference, markets happen.

      • Dan Kunze

        As a non-smoker I would have done better than most in that type of situation/market where cigarettes are currency. I am surprised that the article only mentioned that in passing.