Mankiw And Krugman On Market Efficiency

News accounts of current economic turmoil often stress the differences between economists' views on policy proposals aimed at resolving the financial crisis and lifting the United States out of the current recession. These are differences are significant, as exemplified by a running dispute between Greg Mankiw and Paul Krugman. News accounts reporting that 93% of economists agree that a ceiling on rents reduces the quantity and quality of housing available, or that 93% of economists agree that tariffs and quotas reduce a nation's economic welfare are not interesting.[1]

In " The Views Of Economists And Non Economists On The Economy," I claimed that economists held many views in common that differed from those held by the general public. To illustrate an area of agreement, I quote from Mankiw's favorite textbook, and Krugman's and Wells' textbook on market efficiency and market failure. Mankiw writes,[2]

"These observations lead to two insights about market outcomes"

1. Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay.

2. Free markets allocate the demand for goods to the sellers who can produce them at the least cost.

Thus, given the quantity produced and sold in a market equilibrium, the social planner cannot increase economic well-being by changing the allocation of consumption among buyers or the allocation of production among sellers.

But can the social planner raise total economic well-being by increasing or decreasing the quantity of the good? The answer is no, as stated in this third insight about market outcomes:

3. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus...

On market failure he writes,

A word of warning is in order. To conclude that markets are efficient, we made several assumptions about how markets work. When these assumptions do not hold, our conclusion that the market equilibrium is efficient may no longer be true...

Mankiw then begins a short discussion of market power and externalities.

Krugman and Wells make the same to points; on market efficiency they write,[3]

We know that efficient market equilibrium maximizes total surplus—the gains to buyers and sellers in that market. Is there a comparable result for an economy as a whole, and economy composed of a vast number of individual markets? The answer is yes, but with qualifications. When each and every market in the economy maximizes total surplus, then the economy as a whole is efficient. This is a very important result: just as it is impossible to make someone better off without making other people worse off in a single market when it is efficient, it is impossible to improve upon the outcome of a market economy when each and every market in that economy is efficient. However, it is important to realize that this is a theoretical result: it is virtually impossible to find an economy in which every market is efficient. For now, let’s examine why markets and market economies typically work so well. Once we understand why, we can then briefly address why markets sometimes get it wrong.

They then discuss market failure.

Markets can be rendered inefficient for a number of reasons. Two of the most important are a lack of property rights and inaccuracy of prices as economic signals. When a market is inefficient, we have what is known as market failure. We will examine various types of market failure in later chapters; for now, let’s review the three main ways in which markets sometimes fall short of efficiency.

Krugman and Wells then discuss market power, externalities, and public goods as reasons for market failure. Mankiw also discusses public goods as a cause for market failure, but at a different point in his text.

Economists disagree, sometimes noisily and about important issues. It is not useful nor fun to discuss areas of agreement. Nor is agreement reported; that would be like the evening news announcing that nobody was killed today or that five healthy babies were born. Krugman and Wells make much the same observation.

One important answer is that media coverage tends to exaggerate the real differences in views among economists. If nearly all economists agree on an issue--for example, the proposition that rent controls lead to housing shortages--reporters and editors are likely to conclude that there is no story worth covering...

Remember when you read about disagreements, there is a great deal of agreement not mentioned and it is important too.

[1] Both Mankiw, and Krugman and Wells reference the 1992 paper by Alston, Kearl, and Vaughn, "Is There Consensus among Economists in the 1990's," American Economic Review, May 1992.

[2] Mankiw, Gregory. "Principles of Macroeconomics," Fifth Edition, South-Western CENGAGE Learning, 2009, pages 149-150.

[3] Paul Krugman and Robin Wells. "Microeconomics," Worth Publishers, 2009, pages 111-112.