[PEN-L:28116] The market as a preference aggregator? (again)

["Devine, James" <jdevine@xxxxxxx>]

Title: The market as a preference aggregator? (again)

[unfortunately, MS Outlook has the "save" button next to the "send" one, so I sent this off before it was finished. Let's see if I can move the buttons....]

Awhile back, Gil wrote: > I agree with Justin that it's a bit of a stretch to think of "the market"  as a mechanism for aggregating individual preferences into a "social  preference ordering."  It's more appropriate to think of the market as a mechanism of social *choice*, i.e. as something that selects *particular* outcomes given particular initial conditions (including individual preferences), rather than something that yields a "social preference ranking" based on individual preferences.  The difference, plainly put, is that social preference orderings have to be combined with social constraint sets--the set of what's socially feasible at any given historical moment--in order to yield actual outcomes. To treat the market as a social preference ordering, for example, you'd have to read "social preference" from a given pairwise comparison as "society prefers the allocation that constitutes a market equilibrium over the one that doesn't, and if they both constitute market equilibria, society is indifferent."  Not clear that that makes any sense.<

maybe it doesn't make sense, but this is the way much or most of the _laissez-faire_ school sees it: only the market, in their view, can be the judge of the worth of any item or activity.

Despite their patent ideological failings, maybe it makes sense to see markets as social preference aggregators (just not as good ones). It's true that individuals in markets don't pay attention to social constraint sets. But other modes of collective choice also can be ignorant of social contraints, including democracy.

> But supposing that the market is understood as a social preference aggregator, then I agree with Gar that Arrow's theorem would  apply.  I understand Arrow's impossibility theorem a little differently, though--as I read it, it states that there is no coherent (i.e., complete and transitive) social preference ordering over choice sets with at least three alternatives that simultaneously satisfies

> (U)  Universal domain:  any possible array of (coherent) individual preference orderings is permissible;

> (P)  Pareto principle:  if all individuals (weakly) prefer any some allocation A over some other allocation B, then the social ordering will also reflect this (weak) preference;

> (I)  Independence of "irrelevant" alternatives:  the social ranking of any two feasible allocations does not depend on what other  allocations are included in the choice set;

> (N)  Nondictatorship:  the social ordering will not simply reflect the preferences of any single individual.

> The most obvious way in which the market mechanism, understood in the above sense, would fail as a social welfare function is with  respect to (U),  since it will not generally be true that for any two allocations, at least one will constitute a market equilibrium (however that might be defined--perfectly competitive or otherwise, e.g.).  Fulfillment of condition (I) is also problematic given the possibility of  income effects on individual choices.<

Real-world systems of democracy also typically rule out some preference rankings.

Also, don't you think that condition I is also problematic given the existence (prevalence) of externalities?

JD