Markets with Search Costs — Nobel Prize in Economics?!

I just read the „Popular Information“ about this year’s Nobel Prize Winners in Economics and don’t quite know whether I’m shocked or happy. It’s good stuff like that is being discovered. How very sad that it took till the 70s for this to catch on. Here’s the basic discovery:

According to a classical view of the market, buyers and sellers find one another immediately, without cost, and have perfect information about the prices of all goods and services. Prices are determined so that supply equals demand; there are no supply or demand surpluses and all resources are fully utilized.

But this is not what happens in the real world. High costs are often associated with buyers’ difficulties in finding sellers, and vice versa. Even after they have located one another, the goods in question might not correspond to the buyers’ requirements. A buyer might regard a seller’s price as too high, or a seller might consider a buyer’s bid to be too low. Then no transaction will take place and both parties will continue to search elsewhere. In other words, the process of finding the right outcome is not without frictions. Such is the case, for example, on the labor market and the housing market, where searching and finding are essential features and where trade is characterized by pairwise matching of buyers and sellers.

Granted that the theory is probably far more complicated and formula-laden, I still get the impression that the recent decades of economic research have been spent mostly trying to get common sense back into economic theory. And I am reminded of a wonderful cartoon by the „Standup Economist“ Yoram Bauman about Daniel Kahneman, a psychologist who got the 2002 Nobel Prize in economics for basically this finding:

Taken from an excellent humorous presentation held at the 2010 American Economic Association Annual Meeting (originally coming from his book).

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Datum: Mittwoch, 13. Oktober 2010 0:53
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2 Kommentare

  1. 1

    Well, Christoph, it is true that a lot of time is spent and has been spent getting more realistic assumptions into economic models (often including common sense). And it’s good like that!

    It’s good and it’s non-trivial. Because economic models are usually necessary where you want quantitative predictions or where there are a few „common sense arguments“ going in different directions and you want to see which effects prevail. That’s what the models of D., M. and P. are there for, for the labor market or other markets. And it’s not such an easy thing to come up with good economic models. Unfortunately, journalists often don’t understand this and then we get statements that are awfully close to Bauman’s cartoons…

    Greetings from Amsterdam!

  2. 2

    Oh dear! You caught me being polemic there Matze! I agree that mathematically modeling behavior that is trivial to everyday thinking can still be useful. I think my perpetual criticism with economic theory is which aspects of human behavior they started their models with, and which ones are the „adding some slight extras“ aspects that are only now being „discovered“. You don’t have to be a hard core constructivist to agree that economists have been working with a heavily biased take on reality for a long time. And never (as far as I know) have they argued what makes it useful to choose these abstractions over others. (I’ll try and post some elaboration on this usefulness criterion soon).