While the rest of the world is poring over the works of this years Nobel Prize in Economics winners (um, you are reading Aggregate Demand Management in Search Equilibrium, aren’t you?) I’m still reading one of last year’s winners, Elinor Ostrom. In Governing the Commons, she makes a counterintuitive point about the public goods nature of markets themselves:

A competitive market – the epitome of private institutions – is itself a public good. Once a competitive market is provided, individuals can enter and exit freely whether or not they contribute to the cost of providing and maintaining the market. No market can exist for long without underlying public institutions to support it.

It is an interesting and counterintiutive claim. But what does she mean by this? What, precisely, are the benefits of a pre-existing market that a potential entrant receives?

One benefit is that a new business can observe prices prior to entry, which communicates important information about demand. If you can make a pair of shoes for $20, then knowing what price the market will currently bear is valuable to you, yet you usually won’t need to pay for that information; just see what the competition is charging.

Upstream sunk costs will generally be sunk, so that, for example, a shoe factory does not need to pay the large up front costs of starting a cattle ranch, but can buy leather at marginal cost from existing suppliers.

I do not think she can mean simply the existence of general institutions that facilitate markets, like laws of commerce and a judicial system to enforce it. If this were the case then a market is “a public good” in the sense that any type of cooperation or exchange that benefits from a lack of lawlessness and general rules is a public good. It is more accurate to say that the those institutions are public goods which benefit markets rather than the markets are public goods.

Nor do I think she means laws particular to a market, such as you can’t sell exploding shoes, because for many properly functioning markets, especially very simple ones, no particular laws are needed other than the general laws of commerce.

However, one particular legal area which may be a benefit to new entrants is the existence of standardized contracts which have developed by trial and error over time to be more effective than they would be if one was starting from scratch. However, markets need not currently be functioning for this knowledge to exist.  Functioning markets having existed some time in the past could be sufficient. So it’s not clear that this should be chalked up to the public good nature of markets.

What else am I missing here?

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