Leamer on outsourcing and competition

by Russ Roberts on July 9, 2007

in Competition, Podcast

In the latest EconTalk episode, I talk with Ed Leamer about outsourcing, globalization and a host of related issues. One issue that comes up is the nature of competition when goods are heterogeneous. Ed argues that in such cases, supply and demand is the wrong way to look at such products. There isn’t going to be a single price and deviations from "the" price will be tolerated because of the uniqueness of each transaction. We spar over it a bit. Here’s my attempt to make the case for markets even when every transaction is unique. Graduate students in economics will want to look at Rosen’s work on hedonics.

EDIT: When I said "make the case for markets" above, I meant "make the case for using supply and demand to understand pricing" and to treat such markets as competitive even though each transaction is unique. Leamer implies, if I understood him correctly in the podcast, that heterogeneity and long-term relationships mean that prices aren’t determined by competition and supply and demand in such situations.

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Sam Grove July 9, 2007 at 2:00 pm

make the case for markets even when every transaction is unique.

I suggest that this only bolsters the case for markets. Things are already incomprehensibly complicated without presuming that every transaction is unique.

lowcountryjoe July 11, 2007 at 8:00 am

But transactions do seem to be unique, Sam, and it does get complicated, to a point, but not incomprehensibility so.

I had an "ah ha" moment when I took Intermediate Micro [actually I had several of them] and learned the concept of utility.

Now, when I look at why transactions are made, I consider this concept when trying to understand why some of the transactions I'm following seem to defy, or run counter to, what I would consider normal economic behavior even when one of the things being exchanged is a near commodity.

See, even when a product that is offered for sale is a commodity, the seller can change the product through the amount of service he or she offers or even on his or her personality alone [see Non-price Competition]. These factors can "change the product" being sold through the intangible aspects of the transaction; enough so that a potential buyer can actually realize a commodity's differentiation in the marketplace. This can help explain why a women can buy a pair of shoes at a high-end retailer when a lower-end retailer had the same shoes at a lower price, was closer to home, and the transaction still be a rational one [for her] — the experience of shopping in the high-end retailer met the woman's utility that much more and she was willing to pay extra for the experience [and the shopping bag that can possibly convey catty-like things to other intangibly-conscious women].

More on utility: I know a guy that would drive to a gasoline station further away from home in order to save a few cents on each gallon that he purchased. I asked why and he responded that it was because of the price. Then I followed that question up with the suggestion that he could be using more in gasoline that what he saved in the price of the newly purchased gas, that his real costs might actually be higher for continuing his pursuit. You know what he told me? That it wouldn't matter to him even if it were true because, as he explained, he got a lot of satisfaction from searching for, finding and giving business to the lowest priced gasoline providers. How could I argue with him at that point?

We all know these things psychological factors exist while transactions are being made, it's just that models are tough to build and one wouldn't want to be introduced to the concepts without first learning plain-old supply& demand schedules and graphs.

Sam Grove July 11, 2007 at 11:15 am

But transactions do seem to be unique, Sam, and it does get complicated, to a point, but not incomprehensibility so.

I wasn't referring to any particular transaction as being incomprehensibly complicated, rather the sheer potential numbers of transactions that do take place, or could take place, in the market, without even attempting to consider the sets of priorities each particiapnt carries into transactions.

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