460. Market ideology: variety
In item 57
of this blog I discussed variety of cognition, in cognitive distance, as
both a problem for mutual understanding and an opportunity for innovation by novel
combinations. To profit from the opportunity of innovation one must learn
to cross cognitive distance. A central challenge for entrepreneurs and firms is
to develop the ability to collaborate with others who think and perceive differently.
There are
now three paradoxes of variety. The first is tension between variety and the
efficiency that is claimed for markets. With variety in the form of product
differentiation not all information relevant to the individual is included in
the price. It increases transaction costs in the form of search costs. Consumers
are not always able to fully perceive and assess differences in products. At
the same time, product variety reduces the pressure of price competition that
is supposed to yield allocative efficiency. Also, differences in composition
and quality of goods and services entail that when one chooses one product as
the most preferred one, then to switch to another, different product one incurs
switching costs in making a compromise on what is most desired. That
switching cost for consumers allows producers to raise price above production
cost.
The second paradox
is as follows. While perhaps the strongest argument for markets is that they
tap into the variety of individual, local knowledge, ideas and preferences, in
industrialization increase of scale and concentration of activities into fewer,
bigger organizations have led to a reduction of variety, in mass production.
The mythmarket is one of homogeneous products, and optimal production
technology accessible to all. In facilitating markets there is talk of
creating a level playing field. In
fact, competition is mostly about being different, in differentiating products
and technology, and creating new playing fields.
The third
paradox is as follows. Without institutions markets cannot work. Institutions
are not just laws and their enforcement. They are, much more widely, durable
social (humanly devised) habits and rules that both enable and constrain
behaviour. This includes ethics and morality. They form the basis for
predictions and agreements about future actions. Institutions vary among countries.
Now, the claim for efficient markets is that they are universal, to be applied
everywhere, regardless of varieties of institutions, resulting from differences
of culture, history, political conditions, stage of economic development, and
available resources.
In sum, to profit from the variety of
markets one must accept that competition is imperfect, operates not only on
price but also on quality, and that markets vary with institutions.
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