The simplest ideas can offer the deepest insights into how markets work
TRAGEDY struck at a mid-week game played during the holiday season in Football League Division Two. The pies ran out in the home supporters’ bar. The incident may seem trivial to those not involved, but it illustrates some important themes in economics, which have even gained their inventors the Nobel Prize.
It turns out that the number of away fans was higher than expected. No surprise here. Even distinguished teams of economists regularly make errors in their predictions. Because of this forecasting failure, the away pies ran out first. Away fans are charged 50p more for a pie, so the powers-that-be rapidly diverted pies from the home team bar. This was not on account of politeness towards visitors. There was simply more profit to be made. Incentives matter. This is why, for example, the coalition is keen to reward work and disourage benefit dependency.
But how can this price differential exist? The pies sold to both home and away fans are identical in terms of quality. This is where Joseph Stiglitz enters the scene. Stiglitz is now famous for his polemics on macroeconomic policy. But he received his Nobel Prize for inventing the concept of asymmetric information and showing its consequences for economic theory.
The home supporters have much more information about the price of pies. They buy them every week. But the away fans lack this detailed knowledge. They have a rough idea of the general price of a pie, but lack specific local information. They are therefore happy to pay what is, unbeknown to them, a premium.
Mobile phone companies make great use of this concept. Both phone rentals and phone calls are simple enough products that should be easy to compare across suppliers. But many companies appear to make tariffs as confusing as possible. In so doing, they create asymmetric information. The firms know what is going on. The customers find it hard to work out and compare offers.
But why did trade not spring up in the pies, arbitraging away some of the price differential? Enterprising home fans could have bought a dozen each and offered them to the away fans at only 25p more, creating profit for themselves and benefiting the visitors. A market opportunity seems to have gone missing.
An important reason is the lack of an institutional framework that would create trust among the potential buyers in what might have been offered to them. The away supporters would not unreasonably be suspicious of what was going on if rival fans tried to sell them pies at lower prices. The importance of trust for markets to function properly was a key theme of Nobel Laureate Elinor Ostrom, who sadly died last year. And trust, or rather the lack of it, is a red hot topic in financial circles right now.
The prize in my Christmas quiz was not a pie but a bottle of champagne. Answers will be announced next week.
Paul Ormerod is an economist at Volterra Partners, a director of the think-tank Synthesis, and author of Positive Linking: How Networks Can Revolutionise the World.