2008 February 02 Saturday
Market Responds To Fraud By Lowering Prices?

Marginal Revolutionary Tyler Cowen argues that in markets with fraud prices will drop to eliminate the cost of fraud.

Think just for a moment about what fraud means. Fraud means that the seller is lowering costs, raising revenue and enjoying higher profits.

In the short run that is bad for the customer. But in the long run it means there will be more suppliers and more competition for our business and thus lower prices.

Take the proverbial cheat auto mechanic. Maybe half the time he will charge you even when he hasnít done any useful fixing. But in the long run that extra revenue will draw about twice as many auto mechanics into the industry to compete for your money. Yes, they will be ripping you off half the time but prices will fall by a roughly proportionate amount.

In the long run, you, as a consumer, will do okay. You pay twice as often as you ought to, but as a consolation each time you pay only about half as much.

I do not buy this argument for a few reasons. First off, the fraudulent car repair shops will replace parts that aren't broke. The costs incurred do not get eliminated by lowering salaries of repairmen. Second, the new entrants into the auto industry use more capital to set up shops that is waste. All the repair shops will need to cover their capital costs. There'll be more shops and hence more total capital costs. Third, people pulled into repair are pulled away from other more productive work. Fourth, the fraudulent shops will enjoy higher profit margins than the honest (and likely more competent) shops and this will tend to drive honest shops out of business. So the problem becomes worse.

Update: In the comments "m" points out that taking your car to and from repair shops incurs additional costs that Tyler's argument does not eliminate.

Share |      By Randall Parker at 2008 February 02 08:58 PM  Economics Fraud


Comments
m said at February 3, 2008 8:48 AM:

Amusing,Cowen contends that Bastiat's Broken Windows theory is wrong.

THAT will certailnly impress his fellow economists,now everyone go break some windows,as this will increase economic activity and lower prices!

According to this Cowen should endorse Muslim car buring and rioting as this must be a great boon to the French Economy.

Yet more proof that our "Intellectual Elites" are merely adopting tactical positions based soley on their novelty or short term use in buttressing previously held postions.
I mean:"You pay twice as often as you ought to, but as a consolation each time you pay only about half as much",does Cowen know basic addition and subtraction?
How much cost is invovled with people sitting around waiting for car repairs rather than at work doing something productive,like cleaning his house or cutting his grass?

Question to Cowen,if this is true,why has the endemic fraud of goverment not LOWERED the cost of government?
Why has the endemic fraud of academia NOT lowered tuition rates?

Or perhaps Cowen has merely been misled by the crashing real estate prices into assuming fraud lowers costs??

In sum,Cowen has been masquerading as an economist for years and he's done pretty damn well for himself,so I suppose his defences of criminal fraud makes sense.

averros said at February 3, 2008 2:49 PM:

> In sum,Cowen has been masquerading as an economist for years and he's done pretty damn well for himself,
> so I suppose his defences of criminal fraud makes sense.

He's definitely an expert on this subject. Being one of the (intellectual) fraudsters himself, heh.

But I find it really amusing that most people have a hard time comprehending Bastiat's argument.

averros said at February 3, 2008 2:57 PM:

A propos...

The problem with fraud is that it diverts resources from the people who produce value to the criminals. This reduces ability of the productive people to accumulate capital, and thus lowers investment in production and increases wasteful consumption. Which leads to slowdown (and even reversal, in case of excessively large load of losses to certain criminal activities, such as taxation and inflation) of growth of productivitity. Which means that standards of living are lower than they could've been.


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