(This is an archived page, from Edition 2 of the Patterns of Power book. The current versions is at https://www.patternsofpower.org/patterns/economic/markets/deviations/).
Economic power has been presented, up to this point in the book, in classical terms. Standard economic theory is predicated upon people and organisations behaving rationally in their own self-interest, guided by the invisible hand, to optimise wealth creation. This section looks at some of the ways in which the economy may not always behave as expected:
· Recently some economists have examined the effects of irrational behaviour in markets, describing what is now called 'behavioural economics'. People buy shares that are already rising in value, and continue to hold them beyond the point at which their price can be justified;[1] the dot-com bubble was an example.[2] As already noted (3.3.4.3), these price bubbles destabilise the financial system.
· People are also prepared to apply moral criteria to their choices, as described in the next chapter (4.3.5.2), when they pay extra for products that have been certified as fair trade. Such choices conflict with a narrow definition of their self-interest.
· Network effects, such as fashion, have a large impact in some markets and are hard to predict.[3]
· Innovation can lead to new products and completely new markets.
· Even the weather has an economic impact.
In short, the number of unpredictable factors (and the enormous number and variety of transactions) make precise forecasts impossible. There is now considerable interest in these deviations from standard theory and several books have been written on the subject.[4] These uncertainties mean that governments have limited ability to control markets; little confidence can be placed in long-term forecasts.
Some non-standard behaviour in markets is the result of various forms of abuse, such as fraud and restrictive practices. Regulation can combat many of these abuses when they are within a single country, but it is often difficult to pursue malpractice that originated in another country. In the absence of global regulation, the only defence against many abuses is vigilance which in this book is categorised as Self-Protection (7.2.2).
© PatternsofPower.org, 2014
[1] An article by Richard H. Thaler and Sendhil Mullainathan, entitled How Behavioral Economics Differs from Traditional Economics, describes the irrational operation of financial markets. It was available in April 2014 from the Library of Economics and Liberty at http://www.econlib.org/library/Enc/BehavioralEconomics.html.
[2] Kalen Smith wrote an article entitled History of the Dot-Com Bubble Burst and How to Avoid Another, which was available in April 2014 at http://www.moneycrashers.com/dot-com-bubble-burst/. It described how entrepreneurs overly optimistic expectations of the potential of the Internet created the infamous dot-com bubble (also known as the Internet bubble) of the latter half of the 1990s.
[3] In an essay entitled Networks and the need for a new approach to policymaking, Paul Ormerod defined network effects:
The fact that a person can and often does decide to change his or her preferences simply on the basis of what others do is known in economics as network effects.
IPPR published this essay in August 2012 as part of a collection entitled Complex New World: Translating new economic thinking into public policy; it was available in April 2014 at http://www.ippr.org/publication/55/9499/complex-new-world-translating-new-economic-thinking-into-public-policy.
[4] Two examples are: Economics 2.0, by Norbert HĂ€ring and Olaf Storbeck, published by Palgrave Macmillan in February 2009; and From Poverty to Prosperity: Intangible Assets, Hidden Liabilities and the Lasting Triumph over Scarcity, by Arnold Kling and Nick Schulz, published by Encounter Books, 2009. Arnold Kling was interviewed about his book by Russ Roberts on EconTalk and the podcast, and a transcript of it, were available in April 2014 at http://www.econtalk.org/archives/2009/12/kling_on_prospe.html.