The Efficiency of Markets

A student of microeconomics learns that any competitive equilibrium leads to a Pareto efficient outcome (First Fundamental Theorem of Welfare Economics). What do we mean by the efficiency or inefficiency of markets?

Congressman Henry Waxman: My question is simple. Were you wrong?”

Greenspan: “Partially … I made a mistake in presuming that the self-interest of organizations, specifically banks, is such that they were best capable of protecting shareholders and equity in the firms … I discovered a flaw in the model that I perceived is the critical functioning structure that defines how the world works.

Fama: People who get credit have to get it from somewhere. Does a credit bubble mean that people save too much during that period? I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning. (…)

Cassidy: Are you saying that bubbles can’t exist?

Fama: They have to be predictable phenomena. I don’t think any of this was particularly predictable.

Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.

Do you agree? Tell us what you think in the comments below.

Three years ago, we started working on our blog “Reading Mas-Colell” to present critical commentary on “Microeconomic Theory” by Andreu Mas-Colell, Michael Whinston and Jerry Green, a textbook widely used in Ph.D. programs in economics around the world. We are happy to announce that we are now ready to launch our new course ” Advanced Microeconomics For The Critical Mind”. The course aims to introduce interpretative and contextual content to provide exposure to microeconomics as a domain of unsettled questions and live debates, rather than just a field of applied mathematics.

Please join us in the course for more discussion on the role of mathematics and modeling in microeconomics.

enroll now

Share your perspective

Featured in this article