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Market Failure or Success

The New Debate

Edited by Tyler Cowen and Eric Crampton

Recent years have seen the development of new theories of market failure based on asymmetric information and network effects. According to the new paradigm, we can expect substantial failure in the markets for labor, credit, insurance, software, new technologies and even used cars, to give but a few examples. This volume brings together the key papers on the subject, including classic papers by Joseph Stiglitz, George Akerlof and Paul David. The book provides powerful theoretical and empirical rebuttals challenging the assumptions of these new models and questioning the usual policy conclusions. It goes on to demonstrate how an examination of real markets and careful experimental studies are unable to verify the new theories. New frontiers for research are also suggested.
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Chapter 3: Keynesian economics and critique of first fundamental theorem of welfare economics

Joseph E. Stiglitz


3. Keynesian economics and critique of first fundamental theorem of welfare economics Joseph E. Stiglitz KEYNESIAN ECONOMICS Of all the market failures the one whose impact in eroding public confidence in market processes was the greatest was the Great Depression, the worst example of the periodic slumps that had plagued market economies throughout the centuries of capitalism. The existence and persistence of unemployment can be viewed as providing a convincing refutation of the neoclassical model: for in that model, all markets, including the market for labor, clear. Curiously the debate on market socialism did not focus on the relative macroeconomic merits of the alternative systems, and the historical evidence is of limited value. Though the socialist economies ÔsolvedÕ the unemployment problem, their solution may have been to make it disguised rather than open. The socialist economies did not seem to exhibit fluctuations in growth rates, evidence of fluctuations in economic activity. Still there are theoretical reasons to think that market socialism would alleviate the underlying problem. One of the central themes in recent macroeconomic work has traced economic slumps to Ôcoordination failures.Õ To put the matter baldly, there are no jobs because there is no demand for the output of firms, and there is no demand for the output of firms because people do not have jobs. If the economy was well described by the ArrowÐDebreu model, if there were, for instance, a complete set of markets, then these coordination failures presumably would not occur. Advocates of market socialism...

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