Quo vadis Blockchain?


Can the reputation mechanism be made robust? Can there be a Law Merchant on the internet if miscreants can hide behind encryption?

In some ways, Bitcoin has spawned a new wild West.

The questions then are:

Can blockchain identify a fraudulent transaction?

Will the community of users pre-agree to a readily enforceable clawback or restitution mechanism?



Virtual currencies and their institutions

Or why Bitcoin and its variants are risky assets.

It’s fair to say that virtual currencies need block chain. Block chain is an essential or necessary innovation behind such currencies. That block chain is not sufficient becomes obvious when we consider the question of how many virtual currencies can exist.

This is pretty much a question in institutional economics. It would be like asking which fiat currency would dominate global transactions.

Ronald Coase’s transaction-cost theory of the firm probably has the answer.

The dominant virtual currency is the one with the least transactions cost. While trust is an unmeasurable element that reduces transactions cost, transaction cost can itself be measured.

There are other factors along with trust that augur well for the dominant virtual currency. Among these factors are:

It should have ‘standing’ with central banks if only because they issue legal tender, whereas virtual currencies are not.

Its value in terms of the dominant fiat currencies must be reasonably stable. For now, the leading virtual currency, Bitcoin, fails.

Also equally important is transparency in its creation and modification. It seems that users of a virtual currency will need at least an unwritten constitution that lays out the fundamental laws of the community of users, even if they wish to be as ‘decentralized’ as possible. Again, here, Bitcoin fails, as can be seen with the ongoing ‘fork’ controversy over Segwit2.

CONCLUSION. It’s too soon right now to say that Bitcoin is here to stay.

Pigou vs Coase, as refereed by Demsetz

This is a good summary of the Pigou vs. Coase debate on externalities. I have one comment: That the author should have brought Hayek into the picture. After all, the piece was published in 1996. What follows is a kind of executive summary.

Demsetz sees the debate on externality as one between two ideals: An ideal state (with perfect information) and an ideal market (also with perfect information and zero transaction cost). Taken to the limit, both models do not generally produce identical solutions. It is well known that the initial distribution of wealth and income affects market outcomes. Change that distribution and the economy rests somewhere else. With Pigovian state intervention, one also needs to factor in the initial distribution of wealth and income as a determinant of political process. Still, it is reasonable to imagine that both models arrive at the same end-point if they started with the same initial conditions.

Demsetz then concludes, based only on theoretical considerations, that the choice between the two models is one determined by preferences for freedom and the final (and/or initial) distribution of incomes and wealth.

Once we depart from the ideal to actual governments and markets, the choice between the two solutions would then have to take into account how much information there is (available) in the competing models, and how well they would reduce transaction cost. Here, Hayek would pronounce in favor of Coase, if only because Hayek believes that the market is more capable of ‘discovering’ such phenomena as efficient technologies and consumer preferences. Transaction cost can be seen as another form of externality, so we start to run the risk of arriving at a proverbial slippery slope.

Nonetheless, Demsetz is essentially right. Transaction cost is not at the kernel of Coase; and neither did Pigou ignore transaction cost. What was being debated was who should have the property rights to the externality, a question that economists usually avoid but one that Coase faced head on.

HW for EC 11 – about markets

This assignment is due Jan 18, 2016 by email (hard copy to be submitted in class on Jan. 19).

For the week ending Jan. 15, please read all you can about demand, supply, and markets. Use mainly Mankiw (or any standard textbook) and my lecture notes (Lectures 4, 5, 6, 6A, and 7).

In answering these questions, you may use any source – textbooks, Google, etc. – but you will get no credit if you do not cite your sources. You may organize yourselves in any way to cooperate — or compete — with each other. Please indicate briefly whether you are convinced of your answer, including the reasons as to why or why not.

Each of questions 1-5 is worth 6 pts. Questions 6 and 7 are worth 10 pts. each.  Extra-credit questions are optional.

1. Explain in your own words why opportunity cost is “the next best thing.”  Does the concept of rationality play a role in the explanation.  Explain.

2. Prove the Law of Demand, using (a) graphs; and (b) verbal arguments.

3. What is the relationship between the Law of Diminishing Marginal Utility and the Law of Demand? Explain your answer. Give a proof, if you can, using a numerical example. (Hint: Set up a table of total and marginal utilities for a given consumer, and show what happens to the quantity demanded of a good whose price has gone down.) Extra credit (5 pts.): What happens to the Law of Demand if the Law of Diminishing Returns does not hold?

4. Prove the Law of Supply, using a numerical example based on the assumption that producers-sellers aim to maximize profits.

5. What is the relationship between the Law of Diminishing Returns and the Law of Supply? Explain. Give a proof using a numerical example.  Extra credit (5 pts.): What happens to the Law of Supply if the there is Increasing Returns instead of Diminishing Returns?

6. Explain how the market (equilibrium) price is determined, using (a) the concept of “tatonnement”; or (b) the process by which individual buyers and sellers bargain with each other even though they have incomplete information on what is the correct level of the market price.(Hint: for (b), imagine that a market consists of producers and consumers, and also a third group called “market makers” who buy from producers and sell to consumers.  The market makers keep a stock or inventory of the good, and will make a deal with producers and consumers based on their best guess on the “correct” price for the good.)

7. In Mankiw, there appears to be an inconsistency between his claim that in competitive markets, individual participants cannot affect the market price, and his other claim that if the actual price is higher or lower than the market price, individual participants will or can adjust the price towards the market price.  In other words, how can an economist claim that individual market participants have no power to affect price, but then also claim that their individual pricing and buy-sell decisions will move the price to the equilibrium? Explain your answer.

Explaining the movement of the Invisible Hand

Adam Smith distinguished the market price of a good from its “natural” price, where the latter in Smith’s words is “the central price, to which the prices of all commodities are continually gravitating.” It seems, here, that the natural price is the same as what we today call the long-run equilibrium price in a competitive market.

Smith already had a supply/demand explanation of the movement of the market price, which is what one observes in the market. Excess supply would cause the market price to fall, while excess demand would cause it to rise. Thus, at equilibrium, where supply equals demand, the market price would tend to stabilize.

Smith also broke down the market price of a commodity into its factor-price components – wages, profits, and rents (which are simply the earnings of the production inputs of labor, capital, and land).

Because of competition among producers (and perhaps because wages and rents are not instantaneously adjusted), Smith saw that gyrations of the market price would correlate with movements of profits, and profits/losses provided a signal to producers to enter/exit the market. This is, of course, the Invisible Hand explanation of the working of the market mechanism. The invisible hand would guide people to produce what is demanded in the market, according to the signaling of profits.

Bubble gum and bubble money

Frank & Ernest

There is a fundamental clash between the tenets of democracy on the one hand, and the idea peddled by many economists on the other that we can tame, avoid, or prevent financial crises. The latter is a major preoccupation of the economics cognoscenti, including in the IMF for example.

Continue reading “Bubble gum and bubble money”

Economic performance – what do the experts say?

In a major newspaper, three economic experts gave their reviews of the Philippine economy since 2001. Supposedly, this is to educate ourselves ahead of the annual ritual called SONA.

ECONOMYcartoon2One, Tomas Africa, said that the government did well in sending Filipinos to jobs abroad, but failed to provide good-quality or high-paying jobs in the local economy.

Another, Cielito Habito, said that a fiscal crisis was avoided by a substantial increase in the value added tax in 2005.  Still, the “efficiency” by which the government collects tax has reportedly not improved.  The end result was an inability not only to pare down foreign debts of the government but also to fund crucial expenditures for education, health, agriculture, and infrastructure.

A third, Cayetano Paderanga, Jr., said that economic performance was good in terms of GDP growth (because of OFW remittances), a lowering of the inflation rate, and a relatively strong peso.  But the record in job creation and reduction of poverty was not as good.

Continue reading “Economic performance – what do the experts say?”