Liberal Values and Social Dynamics

There are four types or 'degrees' of liberalism:

  • Pure Liberalism (aka Market Anarchy): this form of liberalism lacks any constraints except for the acknowledgement of property right. This form of liberalism have no government. All trade occurs between individuals in a market that is held to be voluntary and private.
  • Hobbesian Liberalism: this is the same as Pure Liberalism with the addition of a police force (to stop individuals undermining the free market) & army (to protect against external threat).
  • State Liberalism: this employs the principles of Hobbesian Liberalism with the addition of a regulatory body (government). Government is employed to the degree that market efficiency is maintained (and no more).
  • Welfare State Liberalism: within this system social justice and ethics are implemented via social policies so the under-privileged are cared for / aided. Involves the implementation of policies such as unemployment, pension, etc.

The constraints of each form of liberalism increase from pure to state welfare. As these constraints increase in number, the degree to which the assumption of an underlying 'perfect' free market is necessitated decreases.

Liberal Economics

Perfect Free Market

This is a market in which supply and demand are not subject to regulation other than perfect competition, but in which property rights are allocated and upheld so that trade can occur. In such a system price is directly proportional to the demand of an item. Supply is then inversely proportional to price.

In a free market an equilibrium state will be reached where the price of an item should be as low as possible and the quality of the item as high as possible.

Adam Smith and the "Invisible Hand"

Adam Smith (17th century British economist) described the phenomena of the "invisible hand" in a free-market economy in his book "On the Wealth of Nations".

"Every individual endeavours to employ his capital so that its produce may be of greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security, only his own gain. And he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it."

In other words, the selfish goal of increasing your own profit will tend to promote the interests of society as a whole. This is because the means of maximising profits is to produce commodities that are as good as possible as cheaply as possible.
The benefit of the free market is that when it reaches this equilibrium state, it will achieve:

  • The most efficient resources distribution, and
  • The most efficient skill composition

This equilibrium state is called Pareto-optimally ("the resources distributed in the best possible way"). This is formalised as the Duality Theorem, which states:

"The conditions for Pareto-optimality are satisfied under perfect competition and perfect competition ensures Pareto-optimality".

Perfect competition

There are a number of conditions that must be met to ensure we are operating under a truly free market.

  1. No externalities (non-purchasable positive or negative products of society) or publicly-owned goods (ie: government-owned facilities)
  2. No market distortions in the form of monopoly or oligopoly
  3. No institutional inefficiencies (such as contracts or regulations)
  4. Consumer is sovereign (demand is the determining factor of corporate production)
  5. Market is infinitely adaptable (eg: infrastructure)
  6. Information and knowledge are freely accessible (no patents, education directly accessible)

Tragedy of the commons

"The Common" was the communal pasture in a village in medieval Europe.

  • Suppose there are 10 farmers sharing the Common
  • Each put 10 sheep on the Common
  • Each is worth $10 in the local market

We now raise a question:

  • Is it rational for one farmer to put another lamb on the common?…
  • Say this decreases the value of each sheep to $9.10 …

The net gain for the farmer who added the extra lamb is (11 x 9.10 - 10 x 10 =) $0.10.
The net loss of each of the other farmers is (10 x 10 - 10 x 9.10 =) $0.90

Conclusion: What is rational for an individual is not necessarily rational for a community as a whole.

Prisoner's Dilemma

Two prisoners are suspected of being involved in a robbery and arrested under circumstantial evidence. The police are attempting to elicit a confession from one of the prisoners. As an incentive, they state that if one confesses he will be subject to a reduced jail term (1 year), while the other one will get an increased sentence (10 years). If they both confess, each will get a increased sentence (8 years). If neither confesses a conviction will be up to the jury (5 years each).
The rational decision for each prisoner is:

  • Minimise jail sentence (ie: confess)
  • Always chose the shortest sentence amongst a number of alternatives no matter what the other prisoner does (ie: confess)

Of course if both prisoners confess, collectively they will serve 16 years (the most out of all possible combinations). Possible solutions to this problem include:

  • External coercion (external agent with the ability to create a sufficient threat which the prisoners recognise)
  • Mutually Assured Destruction
  • Internal coercion (religious or cultural training / practice)
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