And so, as a result of this, we can say that liability systems, as I said very
early in the course, are not like economic systems.
They are economic systems. Indeed, the system of competitive free
exchange is a way to organize transactions in a certain transactional
environment. Where the costs of bargaining are very
low. Where the costs of bargaining are low, as
we've seen, property rules are sufficient to protect entitlements, and free
exchange allocates resources. And indeed, all property rights, to their
highest value and owners. In this view, liability systems try to
perform much the same set of tasks, but in a different economic environment.
Where free exchange works in an environment of low tranasctions cost, it
doesn't work in an environment of high transactions cost.
And if efficient exchange is to be facilitated in a regime of high
transaction costs, then a liability rules system is the only way to go.
And in this sense, a liability rules system is a system of exchange that
operates in an environment of high transactions cost.
Where the ordinary system of free exchange operates in an environment of
low transactions cost. Let's take a closer look at the operation
of competitive prices and see what it means to say that they are simultaneously
instruments of retribution and deterrence.
In the discussion, we'll start with a qualification as we frequently do.
And we'll assume that competitive exchange is working perfectly.
That is, every single one of the many buyers and many sellers of the identical
goods in question are all perfectly informed about their own preferences.
About the prices of the goods that they will be trading for, about how much
income they have to spend on goods and so on and all transactions costs are zero.
Here, the two key aspects of the assumption are the homogenaity or
identicality of all the goods that are being traded.
And the level of transactions costs low enough to enable all mutually beneficial
exchanges could take place. And we'll call these conditions the
conditions of perfect competitive exchange.
If exchange works perfectly, and here's a key proposition, the price of every good
would be driven by competition down to an equilibrium value.
That is, a value on which there is no pressure to rise or fall.
That represents the smallest possible sum of all the costs that have had to be
borne in order to produce that good. Because goods are homogeneous, every
buyer looks at every seleer and sees each seller selling exactly the same good.
So the only way the buyer has to distinguish between the many sellers of
this identical good, is the price at which the seller is offering the good.
If any seller attempts to offer the good at a price which is higher than the full
cost of producing that good Including the payment for risk taking that we call
profits, paid typically at a market rate of exchange.
If exchange is working perfectly the price of every good will be driven down
to the value that represents the lowest possible cost of production of that
particular good. As I began to say, if any firm tries to
sell a good for a price above the cost of producing that good.
Including the profit that I have described, then competing sellers will
undercut that price and drive the price lower.
This means that the first seller will have to reduce his price as well;
otherwise he won't be able to sell any goods.
This process goes on until it can't go on any more.
No seller will sell a good for less than it costs to make that good, at least
under ordinary conditions. And so, sellers will reduce the price of
their goods under the pressure of competition until the price of the good
exactly matches the cost of producing that good.
Where it will stay because it can't fall any lower and firms remain in business
and, by selling those particular goods. So when the system of competitive
exchange has worked perfectly, at the end of the day, when prices have reached
their equilibrium value. The op-, output price, the price at which
any particular good is being sold, represents the full cost of producing
that unit of output. And making it available to consumers to
purchase in the marketplace. Economists summarize this argument by
saying that firms expand their production of goods until the marginal cost of
producing the next unit of the good. That is, the full cost of all of the
resources that have had to be employed to produce that single unit of output.
When that marginal cost is exactly equal to the output price, then the firm is
operating at it's profit maximizing point, and that's where it will stay.
And so, output prices in this sense, represent the cost of producing goods.
So that the price of any output, of any output, unit of any output represents the
sum of all of the sacrifices that have had to be made by all of the people
around the world who have contributed to the production of this good.
And the price represents the sum of all of those costs, and not a penny more or a
penny less under ideal conditions. When prices have this quality of
reflecting costs of production. Then every buyer must pay the full cost
of producing the good he wants to consume before he may consume it.
So, he only consumes those goods whose consumption by him pays for itself.
That is to say, the price forces every consumer to ask him or herself a
question. And that is, do I value the consumption
of this good more than the sum of all the costs that it took to produce this good,
and make it available for me to consume. If the answer is yes, the consumer will
purchase it and pay the price. If the answer is no, then the requirement
that the consumer has to pay the price before he can consume the good will deter
him from consuming the good. And thus, having the costs of production
imposed on his or her behalf. This leads to an efficient amount of cost
imposition. That is, the only goods that are are
made. And thus the only costs of production
that are incurred. Are those goods which pay for themselves.
Such that the cost of production is smaller than the economic value of that
good to some consumer who will purchase it.
So in this efficient amount of cost in position the total value of all goods to
their holders is maximized. Just a result that we've seen earlier in
the course. And as we've seen this generally does not
deter cost in position absolutely. Every act of production is an act of cost
imposition. You can't make anything without using
something else in order to make it. And therefore, again, every aspect of
production imposes costs on the people who have to sacrifice in order to produce
that particular good. But the exchange system does not
contemplate that no cost will ever be inflicted upon anyone.
Instead, it provides a mechanism that allows people to distinguish efficient
from inefficient cost imposition. And through the mechanism of competitive
prices, it makes people who perform an efficient act of cost imposition
compensate those who have borne their costs.
And if they decided that the act of cost imposition is not worth it to them in
terms of the benefit that they'll receive from compensate from consuming.
Then the requirement that they pay the price will in fact deter them from
consuming the goods. Let me illustrate all of this with a
simple example That is illustrated in the picture by oranges for sale at your local
grocery store. The oranges sit out in a bin.
Customers come and look at the oranges and decide whether they want to purchase
them. As you can see in the picture, prices
cost, excuse me, oranges cost $1.00 a piece.
And in terms of the conversation that we've just had, we can interpret this
$1.00 purchase price for the orange as follows.
That the sum total of all of the costs that have had to be borne by all of the
input owners who have contributed inputs to the production of this orange is
$1.00. Laborers have contributed their labor.
Raw material owners have contributed their raw materials.
Land owners have contributed their land. Transportation owners have contributed
their services to move the oranges from the farm to distribution points, and so
on. Each of these participants in the
production of oranges has had to bear some costs so that the oranges that we
see in the picture are made available to consumers in the store.
And because we're assuming that the orange market is perfectly competitive,
that $1.00 price tag means that the sum total of all the costs borne by all of
these input owners to produce each of those oranges is $1.00.