Partial equilibrium intuitions about choice

Aca

"It is true, in this world, that giving any one person a choice never makes her worse off. But it does not follow, unfortunately, that giving everyone an extra choice will make everyone, or even anyone, better off. That is, to use one of the stylized insults of economists, “partial equilibrium thinking”. If you give me an extra choice, I will only pursue it if it benefits me. But if you give my customer an extra choice, that may very well harm me. If you give everyone a new choice, where the benefits conferred by our own freedom and the costs imposed by the choices of others take us is anybody’s guess.

This fact should be elementary to economists, but somehow it isn’t, at least not when it comes to policy debates. All economists encounter the “prisoner’s dilemma” prenatally. In a prisoner’s dilemma, what is clearly the best “partial equilibrium” choice for every participant — the best choice holding everybody else’s behavior constant — leads to a poor “general equilibrium” outcome when everybody does it. The prisoner’s dilemma is a situation in which all parties would be made better off if everybody involved had an attractive option taken off the table. Another common example is the “tragedy of the commons“. These situations are not at all rare in real life.

It never, ever, follows that creating a new option for people in an economy must make everyone, or even anyone, better off. Economists who worship at the alter of the first welfare theorem and sloppily equate more choice with “more complete” markets need to recall the Theory of the Second Best (ht Yves Smith, long ago). Markets are either complete or they are not. If they are not complete, the kind of intervention often described as “completing markets” (creating new choices, inventing new contracts) might help, but might also lead to very poor outcomes. For example, “more complete” financial markets have recently served to enable banks and institutional investors to customize payoff distributions in order to extract maximum value from government guarantees and foreseeable bailouts."