Public Policy Hotspots
Also available on Charlie's
Economic Theory: Necessary Conditions for
Markets to Achieve Allocative Efficiency
Price theory says that markets achieve allocative efficiency
given that certain conditions are met. Unfortunately, the conditions
aren't like the disclaimers on software that you don't have to read (just
kidding, of course). The caveats are broad, and just about every aspect of
the information technology industry falls into one or another of these
The conditions that must exist for markets to achieve allocative
Perfect competition - Perfect competition means that competitors are
indistinguishable from one another and their products are completely
interchangeable, personal computers have certainly not reached this
point, but the semiconductor marketplace may be getting close.
Perfect information - Perfect information means that buyers and sellers have all
the relevant information on their product and the market, something
clearly not true of most home computer buyers.
Perfect mobility of resources - Perfect mobility of
resources means no lag times, no barriers to entry, and free flow of
capital, resources, and labor. Obvious exceptions to this
condition include training and implementation lag times.
No externalities - Externalities are effects that
accrue to a third party or third parties other than the buyer and
seller of the product, and can be positive
or negative. A classic example of negative externalities is
environmental damage, such as that caused by the chemicals used in
computer chip manufacturing.
No public goods - Public
goods are much like the ultimate in positive externalities: if
they exist, they exist for all parties. The internet
is a quasi-public good, having some of the characteristics of true
public goods such as national defense.
No interdependence - No interdependence means no
collusion or interconnection between buyers decisions to buy and
producers decisions to sell. Clearly for "vaporware"
to work as a strategy, there must be interdependence among software
manufacturers decisions to produce software.
No economies of scale - No economies of scale means
that the cost for additional products must at some point (before the
total need for that product) increase or spell market failure.
In cases where, like software, the cost of an extra unit of production
(marginal cost) is negligible, the biggest competitor in the field
always will have the lowest costs.
No indivisibilities of production
Indivisibilities refers to any factors of production that are
"quantized" in units large enough so as to interfere with
setting production at the appropriate level. The amount of code
required for a new modern operating system is arguably a good example
of a factor of production which cannot exist only in part, and which
limits the number of companies able to effectively compete in that
Not critically large transaction costs - This refers
to costs associated with making the transaction, e.g. identifying
potential suppliers of a software solution that would meet a
particular client's needs, that are not accounted for in the cost of
the product itself from the buyer's or seller's standpoint.
Allocation is only correct for given distribution of wealth
- Shifts in the distribution of wealth invalidate (to some degree) old
models of allocative efficiency. Internet start-ups becoming
billion-dollar companies might have been predicted by an economical
model, but the presence of these companies and the wealth that they
have generated has now invalidated that model at least as far as
allocative efficiency is concerned. Also technology and
economic growth may change the relative values of types of wealth,
effectively redistributing wealth.
*List adapted from Schickele.
When any of these conditions fails to be met, it is termed a market
failure, and it is considered, by economists, the rightful role of
government to correct for these market failures. Obviously classical
economic theory leaves a large role for government to play in the economy.
What are some of the chief areas in technology that
government intervention is warranted? What type economic issues and
theories are involved? And what policies would economists suggest in
these fields? These are the questions that this project seeks to
answer in its evaluation of information technology's public policy hotspots.