<p>Most theorems in economics would satisfy the consensus requirement. However, depending on what you consider to be common sense, different results will qualify. The following are two results that I found sufficiently hard to believe when I first encountered them. </p>

<hr>

<p>The <a href="https://en.wikipedia.org/wiki/Revenue_equivalence" rel="noreferrer"><strong>revenue equivalence theorem</strong></a>, which, according to Wikipedia, implies that </p>

<blockquote>
  <p>any single-item auction which unconditionally gives the item to the highest bidder is going to have the same expected revenue.</p>
</blockquote>

<hr>

<p><a href="https://en.wikipedia.org/wiki/Arrow%27s_impossibility_theorem" rel="noreferrer"><strong>Arrow's impossibility theorem</strong></a>, which, according to Wikipedia, suggests that </p>

<blockquote>
  <p>no rank-order electoral system can be designed that always satisfies these three "fairness" criteria:</p>
  
  <ul>
  <li>If every voter prefers alternative X over alternative Y, then the group prefers X over Y.</li>
  <li>If every voter's preference between X and Y remains unchanged, then the group's preference between X and Y will also remain unchanged (even if voters' preferences between other pairs like X and Z, Y and Z, or Z and W change).</li>
  <li>There is no "dictator": no single voter possesses the power to always determine the group's preference.</li>
  </ul>
</blockquote>

CC BY-SA 3.0
2018-03-14T23:37:46.217Z
@Servaes: Why not? The result was first published in the *Journal of Political Economy*, an economics journal, and Arrow worked on the problem while completing his PhD in --- guess what --- *economics*.
Herr K.
CC BY-SA 3.0
2018-03-15T03:45:09.743Z
Without additional context, the description of the "_revenue equivalence theorem_" seems to imply that auction prices are independent of the item being auctioned, e.g. that a single-item auction for a toothpick would have the same expected revenue as an auction for a yacht, along with other absurdities.  Presumably these absurdities are prohibited, but if so, what seemingly absurd conditions are allowed such that the theorem's counter-intuitive?
Nat
CC BY-SA 3.0
2018-03-15T04:05:28.220Z
@Servaes: Moreover, Arrow's theorem concerns the problem of preference aggregation, which is well within the scope of economics.
Ben
CC BY-SA 3.0
2018-03-15T14:47:54.613Z
@Ben How does economics cover voting?  It's not like "consumers" can somehow earn more votes to "spend" on their preferences, perhaps by "saving" a vote and "investing" it in something that will produce more votes in the future. It's common for nearly half the voters to "spend" their votes and get absolutely nothing in return (having not voted for the winning candidate).
Monty Harder
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2018-03-15T17:22:48.357Z
@MontyHarder: Your thinking is a typical misconception of economics. Of course voters, i.e. consumers of politics, have preference over policy platforms. While most voters are by birth endowed with the right to vote, many others such as immigrants incur high costs in order to "purchase" the right to vote as citizens in a democratic society. The cost-benefit analysis you described at the end is well known among economists as the [paradox of voting](https://en.wikipedia.org/wiki/Paradox_of_voting).
Herr K.
CC BY-SA 3.0
2018-03-15T21:39:46.737Z
@Monte Harder: The problem of voting systems is a part of the broader study of [social choice theory](https://en.wikipedia.org/wiki/Social_choice_theory), which is generally considered to form a part of economics.  This latter theory studies the mathematical properties of functions that attempt to aggregate a set of preferences (e.g., n utility functions) into a single "social preference" (i.e., one utility function) or "social choice" (i.e., one outcome).
Ben
CC BY-SA 3.0
2018-03-16T20:07:54.950Z
@Nat the additional context is given in the link. For a *fixed item*, but *variable type of auction*, the expected revenue is, given certain conditions, fixed. You seem to think that "any auction" means "auctioning off any item", when it instead means "any method of auctioning the item in question".
Acccumulation
CC BY-SA 3.0
2018-03-16T20:17:10.333Z
@Acccumulation The issue isn't my personal understanding but rather making the post complete.  The phrase "_any auction_" means just that: _any auction_.  If it's to be used above, it should be appropriately qualified.  And to clarify, the constraint on it being for the same item was just one example of a constraint that'd need to be stipulated; there're a lot of others.
Nat
CC BY-SA 3.0
2018-03-16T20:22:50.227Z
@Acccumulation Just so I don't come off the wrong way, not trying to be excessively pedantic here or anything.  My concern was just that, by itself, the quote's very misleading.  That theorem's true only in very idealistic models.  But since this is a question about theorems that seem counter-intuitive, it'd be nice to have a statement of when it does apply, to highlight how it might be counter-intuitive in those cases.  I mean, it seems highly counter-intuitive in the general case, but that's actually good because it's not true in the general case.
Nat
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2018-03-19T20:34:11.263Z
@HerrK. To "purchase" the right to vote is not the same thing as to cast that vote and thus "purchase" some good or service from a supplier thereof.  It's hardly a "misconception of economics" to insist that some semblance of what defines economic transactions relate to the situation you're trying to call "economics"  It's precisely because those who vote for a non-winning candidate get nothing in return for the effort they expend that the normal rules of economics are difficult to apply.
Monty Harder
CC BY-SA 3.0
2018-04-02T15:24:39.660Z
@MontyHarder what are the "rules of economics"? A large part of economics is about the allocation of scarce resources. Votes are a scarce resource. So is the choice of candidate/party/policy in an election.
Theoretical Economist
CC BY-SA 3.0
2018-03-13T04:05:16.267Z
2018-03-13T04:05:16.267Z
Herr K.
<p>In an open economy, <a href="https://en.wikipedia.org/wiki/Saving-investment_balance" rel="noreferrer"><strong>the balance of payments current account equals net saving</strong></a>. This is often represented as:</p>

<p>$$S - I = X - M$$</p>

<p>where $S$ is saving, $I$ is investment, $X$ is exports and $M$ is imports.
That is admittedly a slight over-simplification as current account includes not only exports and imports of goods and services but also other items such as income from foreign investments or employment abroad, and foreign aid.  For many countries, however, the net amount of these other items is relatively small so that the balance on trade in goods and services approximates fairly closely to net saving.</p>

<p>This appears to diverge from common sense since, if a country has a trade deficit, most non-economists looking for explanations will consider possibilities such as:</p>

<ul>
<li>lack of competitiveness of domestic firms;</li>
<li>'dumping' by foreign producers;</li>
<li>'unfair' international trade agreements;</li>
<li>an overvalued exchange rate.</li>
</ul>

<p>Very rarely will a non-economist suggest that a trade deficit has anything to do with levels of saving and investment.</p>

<p>Note that saving and investment here include those of both the private and the government sectors. So one implication of the above is that a government deficit, unless offset by private sector net saving, will be associated with a trade deficit (just 'associated' because the direction of causation is a further question).</p>

CC BY-SA 3.0
2018-03-14T04:40:05.503Z
It seems common-sensical enough that the trade surplus - being the amount of money your country has made from selling stuff that it hasn't yet used to buy stuff - would be equal to the total savings in the country since on an individual level that is the definition of savings...
Criticize SE actions means ban
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2018-03-14T05:21:28.803Z
Also all of the above factors would seem to ultimately relate to income and expenditure, which relate to savings.
Criticize SE actions means ban
CC BY-SA 3.0
2018-03-14T10:19:22.777Z
@immibis Your comments appear to be based on an introspective approach to common sense ("this is how it seems to me").  And certainly this is not a proposition that needs advanced maths to be proved.  My point is that it isn't commonsensical in the sense that non-economists rarely show understanding or awareness of it.
Adam Bailey
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2018-03-15T06:04:21.603Z
I wonder if it's just because nobody wants to think about the prospect of spending less money.
Criticize SE actions means ban
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2018-03-16T03:34:56.137Z
Can you edit this to say what S, I, X, and M stand for?
curiousdannii
CC BY-SA 3.0
2018-03-16T10:12:02.267Z
This only seems to mean that countries with a trade surplus will have to put this surplus somewhere ...
Moreover, this balance theorem doesn't answer the cause of trade deficit, while the 4 allegedly stupid explanations do.
agemO
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2018-03-16T11:08:18.503Z
@curiousdannii  Done!
Adam Bailey
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2018-03-16T11:10:52.383Z
@agemO  I'm not suggesting that the 4 explanations are stupid, only that they are not the whole picture.
Adam Bailey
CC BY-SA 3.0
2018-03-13T10:41:55.413Z
2018-03-16T22:31:49.923Z
2018-03-16T22:31:49.923Z
Adam Bailey
<p>The <strong>Giffen Paradox</strong> - increasing prices can lead to higher demand even if the goods are considered inferior.</p>

<p>General consensus is increasing prices lead to less demand - if it's more expensive, people will buy less.</p>

<p>In some cases, increasing the price will make consumers perceive a good to be of higher quality, or more desirable, thereby increasing demand. (Example - if iPhones cost only one third of what they do, nobody would spend their money on a phone that doesn't even run Android).</p>

<p>However, even with inferior goods, rising prices can lead to higher demand. This paradox was first observed by Giffen in the 19th century, when rising potato prices meant poorer people weren't able to afford the occasional egg or piece of meat anymore, buying more potatoes instead.</p>

CC BY-SA 3.0
2018-03-13T18:02:18.110Z
This could possibly be called an "observation" more than a "result", but it's something that's easy to comprehend once you read the explanation, but hard to wrap your head around without an example.
Guntram Blohm
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2018-03-14T13:45:06.250Z
Depending on who you talk to, an iPhone might be a perfect example of an inferior good ;)
curiousdannii
CC BY-SA 3.0
2018-03-14T18:08:22.000Z
This is similar to the response of thrifty savers to falling interest rates: "We better save more to compensate!" Which thwarts political efforts to stimulate spending.
MarkHu
CC BY-SA 4.0
2020-01-25T02:57:55.937Z
For many years the real world evidence of Giffen goods was very poor. The evidence from potatoes in the 19th century is discredited. I believe Battalio, Kagel , Kogut (1991) are the first to provide hard evidence, from experiments. We didn't get real world evidence until Jensen and Miller (2008). Most people who believe in Giffen goods probably do so based on low quality or falsified "evidence".
BKay
CC BY-SA 3.0
2018-03-13T18:00:04.743Z
2018-03-15T12:03:28.223Z
2018-03-15T12:03:28.223Z
Guntram Blohm
<ol>
<li><p>The fact that the burden of a tax on sellers can by borne by buyers, and vice versa. More generally, the fact that true tax incidence is largely or completely unrelated to who is nominally being taxed (e.g. taxes on yacht purchases can in principle hurt the poor more than the rich, etc.).</p></li>
<li><p>The fact that in a perfectly competitive market with free entry and exit, all firms make zero profits in the long run (if opportunity costs are taken into account).</p></li>
<li><p><a href="https://en.wikipedia.org/wiki/Coase_theorem" rel="noreferrer">Coase's theorem</a>: "if trade in an externality is possible and there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property". (E.g. under a cap-and-trade system for pollution permits with sufficiently low transaction costs, the final allocation of permits is independent of the initial allocation, even if some permits are sold and others are arbitrarily given away for free.)</p></li>
<li><p>This one's a bit more "in the weeds", but the difficulty of eliminating the <a href="https://en.wikipedia.org/wiki/Marriage_penalty" rel="noreferrer">marriage penalty</a>: "it is mathematically impossible for a tax system to have all of (a) marginal tax rates that increase with income, (b) joint filing with income splitting for married couples, and (c) combined tax bills that are unaffected by two people's marital status."</p></li>
</ol>

CC BY-SA 3.0
2018-03-14T11:05:42.603Z
Any link to explain nr 1? It sounds completely counterintuitive
JollyJoker
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2018-03-14T12:03:57.317Z
I am guessing because sellers can 'pass on' the cost of taxes to their buyers via increased price, with equivalent processes working the other way, and this passing on of cost propagating through an economy is how yacht purchase tax could theoretically land on people far removed from yacht buyers?
benxyzzy
CC BY-SA 3.0
2018-03-14T18:03:00.180Z
@benxyzzy I wasn't thinking it would land on people "far removed" from yacht buyers, but rather on yacht manufacturers. If the demand for yachts is much more elastic than the supply, then a large tax on yacht purchases would cause the before-tax price to drop much further than the after-tax price rises, so that the wealthy purchasers are only affected modestly, but the (probably poorer) manufacturers get hit really hard.
tparker
CC BY-SA 3.0
2018-03-14T18:03:03.310Z
I'm calling foul since this proposes 4 different ideas, with different levels of detail. Also, #2 is especially arguable since it is about an impossibly idealized theoretical situation populated by mindless actors (i.e. in the real world, not all actors choose to enter all profitable markets, and the smart early-entry firms should not stick it out in the face of decreasing-profits.)
MarkHu
CC BY-SA 3.0
2018-03-15T10:09:54.513Z
@MarkHu As for #2, "the long run" is the key phrase. You will eventually reach a zero-profit equilibrium *if there's no innovation or change in demand etc.*. With change, the market does tend towards this equilibrium, but the target keeps moving and is never really reached (and in a tiny proportion of the cases, never even gets close). But if you look at the average, there's very little profit in the *bulk* of human trades - don't get yourself distracted by the few outliers (and state-granted monopolies). Not perfect, but not a fairy tale either.
Luaan
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2018-03-15T12:18:45.093Z
@tparker Wouldn't that require that yacht manufacturers are locked into manufacturing only yachts? Are we talking people or companies here?
JollyJoker
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2018-03-15T17:05:01.130Z
@JollyJoker Sales taxes hurt yacht manufacturers whether or not they're locked into the industry. If they choose to keep selling yachts, they're hurt by the forgone sales and lower after-tax sale price. If they choose to go into other industries, they increase the supply of labor in those other industries and therefore push down the wage. The same argument holds for buyers, with "supply", "down", and "wage" replaced by "demand", "up", and "price" respectively. If this weren't the case, then the government could use targeted sales taxes as a free lunch for raising revenue without harming anyone
tparker
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2018-03-17T02:02:24.650Z
I guess for 4., you could just allow joint filing (+ income splitting) for non-married couples too ;-)
Paŭlo Ebermann
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2018-03-17T06:26:47.217Z
#4 isn't in the "counterintuitive but true" category; rather, it's in the "summary is false, full explanation is obvious" category. It's easy for a tax system to eliminate the marriage penalty, either by allowing married partners to file as if they were both single, or by setting the tax bracket thresholds for married couples at double the corresponding thresholds for single people.
ruakh
CC BY-SA 4.0
2019-10-09T21:21:17.973Z
@ruakh, your "setting the tax bracket thresholds for married couples at double the corresponding thresholds for single people" proposition won't work if the married people have different incomes and tax bracket is progressive. It's straightforward to show that the only tax scheme that satisfy b and c and has overall (although not marginal) tax rate increasing with income is T=A*income-B, where T is tax amount, A is fixed percentage, and B is fixed amount.
Michael
CC BY-SA 4.0
2019-10-10T03:34:33.320Z
@Michael: I think you must have misread my comment somehow. (Specifically, I think you must have missed the first sentence . . .) My solution that you quote works perfectly for "eliminating the marriage penalty" in exactly the situation you describe; it's true that it doesn't "satisfy b and c" (specifically: it doesn't satisfy c), but neither b nor c is a requirement for "eliminating the marriage penalty".
ruakh
CC BY-SA 4.0
2024-11-14T12:46:47.410Z
On 2, surely that's just a particular case of the more general rule that in a perfectly ideal market the expectation value of any security or speculative investment is the same, which is counterintuitive, obvious with a bit of thought, and completely irrelevant because no such markets have ever existed
user1567459
CC BY-SA 3.0
2018-03-13T22:16:36.313Z
2018-03-13T23:48:46.447Z
2018-03-13T23:48:46.447Z
tparker
<p>Best price clauses and, to a lesser extent, price-matching guarantees have been the subject of intense regulatory activity in recent years. Here's a fact that is surprising to many, despite there being a significant consensus in the economics profession:</p>

<blockquote>
  <p>Best price clauses and price-matching guarantees can harm competition and consumers</p>
</blockquote>

<hr>

<p>A <strong>best price clause</strong>/most favored nation clause/price-parity clause requires a seller listing a price via one venue (e.g. a price comparison website) to ensure that the price listed there is no higher than that available through other similar venues. It is often imposed by venue operators to ensure their venue will attract customers. Common sense suggests that a clause requiring a vendor to be offered the <em>lowest</em> available price should be, at worst, neutral for consumers.</p>

<p>Suppose there are two venues, $A$ and $B$, that a seller can sell through. Suppose both are large suppliers of business to sellers, so simply quitting one of the venues is not a viable option.</p>

<p>Here's the problem: if venue $A$ charges a commission of $c_A$ to sellers who sell through its platform and venue $B$ charges commission $c_B&gt;c_A$ then sellers will set a lower price on $A$ than on $B$ to try to steer consumers to buy through venue $A$ (where it pays lower commission). Thus, a venue can have consumers steered towards it by cutting its commission--venues compete in commission. Moreover, lower commissions (which are essentially a variable cost for the seller) are passed-through to consumers in the form of lower prices.</p>

<p>Now suppose there are best price clauses in effect. If $c_A&lt;c_B$ then sellers can't steer consumers towards $A$ by setting a lower price on $A$ because $B$'s best-price clause requires the price on $B$ to be no higher than that on $A$. Thus, $A$ can no longer attract customers by cutting its commission, and so has no incentive to compete in its choice of $c$. This results in higher $c$s and higher consumer prices. This effect is theoretically robust and empirically well-validated.</p>

<hr>

<p>A <strong>price matching guarantee</strong> is a promise from a seller to a consumer of the form "If you find the same product at a lower price elsewhere, I'll beat that better price". Common sense suggests a guarantee to beat the lowest price in the market should be good for consumers. Not necessarily so.</p>

<p>Here's a rough illustration of why: Suppose sellers A and B both have price-matching guarantees and consumers have a preferred seller from whom they buy by default unless the other seller offers a better deal. Normally, sellers would cut their prices to try to attract consumers from their rival. But here that doesn't work! If A cuts its price then the consumers whose default is B can just go to B and get it to match A's reduced price. But this means A has no benefit from lowering its price and will just stick with the same high price that it had all along. The price-matching guarantee has completely killed price competition!</p>

CC BY-SA 3.0
2018-03-17T14:45:36.570Z
Isn't this *exactly* common sense? Why else would sellers use price matching guarantees rather than actually lowering prices?
mattdm
CC BY-SA 3.0
2018-03-17T18:51:54.987Z
@mattdm Well, one could easily tell a story about consumers who face search or shopping frictions and therefore can't be sure where the lowest market price is (or firms that can't perfectly monitor rivals' prices and sometimes end up charging more than rivals by mistake). Such a guarantee would then plausibly be beneficial for consumers. In any case, it was a big battle for economists to get competition policy makers (who are more informed than the general public) to see the potential equilibrium harm of these things, suggesting that it's not that common sense.
Ubiquitous
CC BY-SA 4.0
2020-02-11T15:43:37.997Z
If the price is the same at A and B then, unless there's a *pretty big difference* in customer service etc, I'll just buy the product from whichever one I happen to visit second. Which, actually, might be the worse one, if I'm in the habit of checking my preferred store first. Otherwise I have to go back to the first store.
Criticize SE actions means ban
CC BY-SA 3.0
2018-03-15T12:44:47.453Z
2018-03-15T12:44:47.453Z
Ubiquitous
<p><strong>Lowering income tax rates can in some circumstances increase revenue</strong>.  A simplistic view would assume higher taxes = higher revenue, but it doesn’t account for the fact that different tax rates alter behavior.  It becomes obvious when you look at the extreme end — with a 100% income tax rate, nobody would bother having a job, because they don’t get to keep any of their wages. Government income from the tax would plummet.</p>

<p>The overall concept is described in a theory called The Laffer Curve</p>

CC BY-SA 3.0
2018-03-13T19:54:14.573Z
I've edited your first sentence to try to clarify it.  Please feel free to reverse my edit if it doesn't capture what you meant.
Adam Bailey
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2018-03-14T00:48:48.443Z
I don't think this is far from common sense.
Criticize SE actions means ban
CC BY-SA 3.0
2018-03-14T00:51:22.950Z
I’ve often encountered people who believe the concept of the Laffer Curve to be false; that *obviously* higher tax rates increase government revenues. Pay a bit of attention to politics and you’ll see it quite often
Stephen R
CC BY-SA 3.0
2018-03-14T10:54:26.677Z
The interesting question here is whether the "some circumstances" actually exist anywhere at present. If the circumstances don't exist, i.e. no actual current taxes can be reduced to increase revenue, then the theory is simply an abstract curiosity and common sense doesn't come into it.
Mike Scott
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2018-03-17T05:25:46.597Z
The basic principle of the Laffer curve is irrefutable. However, I'm skeptical that there is a society anywhere that is actually on the high end of the curve (i.e. that would increase revenue by lowering taxes). Even Ronald Reagan's fans don't seem to talk about the Laffer curve much anymore.
Kef Schecter
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2018-03-17T12:45:29.060Z
It worked for Reagan just fine. We’ll see if it works for Trump; but the fact that companies are repatriating billions of overseas dollars suggests it might.  (The difficulty administrations seem to have is to *not* increase spending at the same time, but government revenues definitely went up under Reagan.)
Stephen R
CC BY-SA 3.0
2018-03-17T14:42:55.570Z
At the very least, I don't think the idea that Reagan-era tax cuts "worked just fine" is settled consensus — https://www.washingtonpost.com/news/fact-checker/wp/2017/11/08/did-ronald-reagans-1981-tax-cut-supercharge-the-economy/?utm_term=.0922d9cd70a9
mattdm
CC BY-SA 3.0
2018-03-17T17:55:37.150Z
You’re article argues an entirely different point— whether those tax cuts boosted the economy. The question at hand is whether or not government revenues from the income tax went up or down. That they went up is really not a matter of opinion
Stephen R
CC BY-SA 3.0
2018-03-18T17:12:31.523Z
@Kef Schecter The UK had income taxes of 90% during the 1950s-60s, and in the 1970s the top rate on investment income went as high as 98%. This caused the Beatles to emigrate to the USA, along with a lot of other rich but less famous individuals.
James Hollis
CC BY-SA 3.0
2018-03-22T06:53:43.297Z
@StephenR Reagan raised taxes and closed tax loopholes after they found they didn't have a lot of money. After adjusting for inflation and population growth on top of that, it's hard to attribute any revenue gain to cutting taxes. See for instance https://krugman.blogs.nytimes.com/2008/01/17/reagan-and-revenue/
Kef Schecter
CC BY-SA 3.0
2018-03-13T18:09:43.123Z
2018-03-13T21:12:31.540Z
2018-03-13T21:12:31.540Z
Stephen R
<p><strong>(Tradeable) Permits</strong></p>

<p>The fact that you can correct for externalities with (tradeable/marketable) permits seems to be a consensus with economists. But considering the existing applications, the theory appears to be not common sense.</p>

<p>Example:</p>

<p>The EU/countries in the EU have implemented a <a href="https://en.wikipedia.org/wiki/Carbon_emission_trading" rel="nofollow noreferrer">Carbon Emission Trading scheme</a> while nations within the EU continue with other regulation like promotion of solar/wind, etc. When the point of a permit trading scheme is for the market to allocate the efforts to that place where you can save CO2 most efficiently. The added regulation only distorts the permit market without actually helping to reduce the CO2 produced, as the amount of CO2 produced is set by the amount of permits issued. And by funding solar, you just make permits cheaper and increase pollution in another sector.</p>

<p>Another quirk is, that permits are grandfathered to companies to keep the prices down, when the gifted permits result in an opportunity cost of using them (since you could sell them at the same price), making the price rise at just the same rate as if the company had bought them. The only result of grandfathering being that it gifts money to established companies, distorting the market. </p>

<p>To address some further concerns in the comments: </p>

<p>If the amount of issued permits were to high this would still be an example of policy makers not understanding the theory of permits. The thing is, either you base your CO2 reduction policy completely on permits or not at all. If you issue too many of them, then they don't have an effect and the only reduction comes from other measures so the implementation of permits is bad. But if they are actually binding (i.e. there are less permits than people want to produce) then all the other measures have no effect as they only shuffle around where the CO2 gets produced. So the implementation of other measures is bad.
In either case there seems to be a lack of understanding of how permits work. </p>

<p>And I also want to argue that there are not too many permits anymore, the surplus was due to the crisis in 2008. And while I would still argue that the amount issued is still too high, the price is high enough above zero, that a reduction of CO2 in one place would probably lead to an increase in a different place. But again, it does not really matter. The issue is, that they did not implement a theory in a way that it actually works properly.</p>

CC BY-SA 3.0
2018-03-16T19:44:28.053Z
This answer might be clarified by using a different term than "certificate" --that word does not appear in the article at https://en.wikipedia.org/wiki/Carbon_emission_trading wiki page. Maybe simply "permits," or more descriptively "regulatory permits and fees." In which case it becomes apparent that this so-called "market" for carbon is not much different than any other system of regulation via fees and/or fines. The main feature being the explicit waiver "price" (penalty.)
MarkHu
CC BY-SA 3.0
2018-03-16T22:43:01.383Z
Isn't the standard economists' terminology for this "marketable permits" (or "tradable permits")?   And the popular name "cap and trade"?
Adam Bailey
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2018-03-18T19:44:54.187Z
The example seems to be flawed. The amount of CO2 produced is **not** set by the amount of permits issued in the ETS: there's a massive surplus of permits, hence their rock-bottom price. The amount of CO2 produced in regulated sectors is significantly less than the amount of permits issued.
410 gone
CC BY-SA 3.0
2018-03-19T21:30:18.277Z
Maybe the economist's "consensus" is wrong, and the commoners are right. @EnergyNumbers is correct to question how closely the artificial "market" can mirror the real world. Assuming cooperation from all actors is a stretch, depending on how antagonistic they become after the new rules are imposed on them.
MarkHu
CC BY-SA 3.0
2018-03-20T20:30:04.483Z
what do you mean by "cooperation from all actors"? If you don't buy permits when producing CO2 you will have to pay a penalty. So as long as the penalty is above that price it does not make sense to "not cooperate"
Felix Benning
CC BY-SA 3.0
2018-03-14T08:30:38.533Z
2018-03-20T20:26:02.043Z
2018-03-20T20:26:02.043Z
Felix Benning
<p>I’m going to toss my hat into the ring with <em>the very notion of</em></p>
<h1>Opportunity Cost</h1>
<p>Who hasn’t argued with someone who “likes” A, which has an opportunity cost B, and have that person adamantly refuse to consider the loss of B as a cost for A or in any way relevant to the choice to get A? If you’ve ever tried to persist in such a situation, I’m sure you also quickly found the other person getting offended, as if you were insulting A and/or them for liking A.</p>
<p>A large part of the problem is, of course, the not-so-subtle verb substitution I used: the person in question here is talking about, and thinking about, “liking” A. The speaker, you or I in the hypothetical, is instead talking about the decision of whether or not to procure A. The argument is, fundamentally, that A can be good, worth “liking,” but not worth it—because of the opportunity cost B. And if anyone knows of a good way to explain that and assuage hurt emotions over feeling attacked for liking A, I’m all ears! Recognizing the problem does not itself produce a solution to it.</p>
<p>Anyway, unlike a lot of other issues on this page, which are important but not a daily concern, opportunity cost is, or at least could be, at the heart of just about every decision every person makes. It is relevant to all people, but a lot of people seem to not just ignore it, but to actively disdain the very concept. Therefore it seems, to me, like a strong contender here.</p>

CC BY-SA 3.0
2018-03-18T01:43:07.417Z
See: Ferraro Paul J & Taylor Laura O, 2005 "[Do Economists Recognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science](https://ideas.repec.org/a/bpj/bejeap/vcontributions.4y2005i1n7.html)". The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 4(1), pages 1-14, September. (The paper is widely available and discussed elsewhere on the internet. 78% of economists gave the wrong answer to a basic multiple choice question on opportunity costs, although the wording of the question has been criticised by others.)
Silverfish
CC BY-SA 3.0
2018-03-18T01:44:26.293Z
The question they posed was: "You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost 40 dollars. On any given day, you would be willing to pay up to 50 dollars to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) 0 dollars, (b) 10 dollars, (c) 40 dollars, or (d) 50 dollars."
Silverfish
CC BY-SA 3.0
2018-03-18T10:43:36.353Z
@KRyan: Can I suggest you delete your comment so that others who wish to contemplate the problem on their own before looking up the answer are not influenced by your answer? There's no need to ask here if you're correct; you can find the correct answer yourself, plus the reasoning behind it, in [the paper](https://ais.ku.edu.tr/course/17404/ferrarotaylorbep.pdf).
cjs
CC BY-SA 3.0
2018-03-18T13:52:11.710Z
@Curt Sure, but no I could not have done that, because Silverfish’s link wanted to charge money to access the paper.
KRyan
CC BY-SA 3.0
2018-03-18T17:51:30.230Z
It's always worth trying a quick web search. That's how I got the link to a free copy in my comment above. (I don't know how long it will last, which why I'm mentioning here how I found that link.)
cjs
CC BY-SA 3.0
2018-03-15T20:16:03.980Z
2018-03-15T20:21:55.447Z
2020-06-17T09:40:54.643Z
KRyan
<blockquote>
  <p>Price discrimination can make consumers better-off</p>
</blockquote>

<p>This can happen in a variety of ways. For example, suppose that 50% of consumers are 'loyal' to firm A and 50% loyal to firm B. A consumer is willing to pay $v$ for one unit and incurs a switching cost $s\in(v/2,v)$ if they buy from a firm other than the one to which they are loyal. Consumers buy from the firm offering the highest utility, breaking indifference in favour of the firm to which they are loyal.</p>

<p>If firms must offer the same $p$ to all consumers then, the only pure strategy equilibrium has $p_A=p_B=v$.</p>

<p>If we allow firms to price discriminate by offering different prices to loyal and non-loyal consumers then $p_i=v$ is never an equilibrium and there is an equilibrium in which $p_i^{\text{loyal}}=s$, $p_i^{\text{non-loyal}}=0$.</p>

<p>Without price discrimination firms don't compete to attract the rival's consumers. Intuitively, it takes a price cut of at least $s$ to do so, but that means also losing $s$ units of profit from loyal consumers who also benefit from the price cut. With price discrimination, on the other hand, a firm can fight for its rival's loyal without sacrificing any profit on its own. But this goes in both firections so both firms end up having to fight for their loyals against a rival that is trying to poach them.</p>

<hr>

<p>Another ways that price discrimination can benefit consumers is by giving a firm enough profit to make a product viable (otherwise the product wouldn't get produced at all, leaving consumers with zero surplus).</p>

CC BY-SA 3.0
2018-03-15T12:27:00.467Z
2018-03-15T12:27:00.467Z
Ubiquitous
<p>There is the monetary <a href="https://en.wikipedia.org/wiki/Impossible_trinity" rel="nofollow noreferrer">Impossible trinity</a> concept in international economics:</p>
<p>The impossible trinity (also known as the &quot;trilemma&quot; ...) is which states that it is impossible to have all three of the following at the same time:</p>
<ul>
<li>a fixed foreign exchange rate</li>
<li>free capital movement (absence of capital controls)</li>
<li>an independent monetary policy</li>
</ul>
<p>Granted there may not be much &quot;common sense&quot; thinking on such an esoteric concept. But the Economist magazine thinks it is pretty important <a href="https://www.economist.com/news/economics-brief/21705672-fixed-exchange-rate-monetary-autonomy-and-free-flow-capital-are-incompatible" rel="nofollow noreferrer">according to <em>The Economist</em></a>. Also, more people are becoming aware of such things since the blockchain and cryptocurrency popularity surge in late 2017.</p>

CC BY-SA 4.0
2020-02-11T15:47:10.020Z
Common sense tells me you can't have #1 and #3. Then you might tell me about capital controls and I might go "oh yeah, I guess that would kinda work, though it causes its own problems."
Criticize SE actions means ban
CC BY-SA 4.0
2018-03-14T01:54:55.187Z
2021-02-12T12:00:03.183Z
2021-02-12T12:00:03.183Z
MarkHu
<h1><a href="https://en.wikipedia.org/wiki/Jevons_paradox" rel="noreferrer">Jevons Paradox</a></h1>

<p>Let's say current engine technology allows vehicles to go one mile on a gallon of gas. Improving engine technology to achieve 10 MPG must decrease the amount of gas used, right?</p>

<p>Actually it depends. Increased efficiency has two effects. One effect is that per unit of distance, less gas is consumed. Another effect is that driving one unit of distance is now cheaper, increasing travel. How much travel increases depends on how much the demand curve rises moving from the old unit price to the new unit price. In fact <em>travel can increase by a larger factor than efficiency increases</em>, leading to more fuel consumption.</p>

CC BY-SA 3.0
2018-03-16T19:08:13.363Z
It would be helpful if you could include in your answer a link to a relevant source.  I was aware of this "paradox" but unaware that it had been named after Jevons.
Adam Bailey
CC BY-SA 3.0
2018-03-16T19:29:21.593Z
@AdamBailey I added link.
Reinstate Monica
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2018-03-17T09:08:23.970Z
This is conceptually related to the notion of [risk compensation](https://en.wikipedia.org/wiki/Risk_compensation).
Ubiquitous
CC BY-SA 3.0
2018-03-17T15:35:30.543Z
@Ubiquitous Yes, it is, and both profoundly affect public policy...
Reinstate Monica
CC BY-SA 3.0
2018-03-16T13:47:30.190Z
2018-03-16T19:22:24.847Z
2018-03-16T19:22:24.847Z
Reinstate Monica
<p><strong>It is rational to defect in the Prisoner's Dilemma</strong></p>

<p>Cooperation is socially optimal in the <a href="https://en.wikipedia.org/wiki/Prisoner%27s_dilemma" rel="noreferrer">Prisoner's Dilemma</a>, and in this economists and non-economists typically agree. However, the rational, i.e. the <em>individually</em> optimal choice, is to defect. From the game-theoretic point of view this is trivial, since the payoffs of the Prisoner's Dilemma game make defection a strictly dominant strategy. But it is notoriously difficult to get non-economists to agree to this reasoning. After all, if both prisoners cooperate, this makes both of them better off compared to bilateral defection, so isn't this proof enough? Ken Binmore’s (2007) <em>Game theory: A very brief introduction</em> contains several different lines of reasoning people have come up with to support cooperation as the individually optimal choice; all of them flawed.</p>

CC BY-SA 4.0
2020-02-11T12:45:27.820Z
2020-02-11T12:45:27.820Z
VARulle
<p>The assumption of the rationality of the agents is a consensus on neoclassical economics and other schools, that is often badly translated to real world examples by economists, due to the difficulty of measuring utility. </p>

<p>The <a href="https://en.wikipedia.org/wiki/Dictator_game" rel="nofollow noreferrer">dictator game</a> translates this idea quite clearly: <s>game theorists</s> some economists claim humans often act “irrationally” when making offers larger than zero. Their mistake is to assume the utility outcome of the player is equal to the monetary outcome. </p>

CC BY-SA 3.0
2018-03-17T07:25:54.927Z
I am a game theorist and I do not claim that. Nor would most game theorists I know.
Giskard
CC BY-SA 3.0
2018-03-18T23:44:20.597Z
Edited. Happy to hear that - although not the same in the 3 universities that I've studied. Even if they wouldn't write it, this would be often claimed in classes and discussions.
JoaoBotelho
CC BY-SA 3.0
2018-03-19T08:02:28.997Z
Thanks. I think most professors would probably make the same nuanced statement that I would make: If you accept the assumption that people want to maximize their payment then according to this model they act irrationally.
Giskard
CC BY-SA 3.0
2018-03-14T04:39:32.290Z
2018-03-18T23:41:14.797Z
2018-03-18T23:41:14.797Z
JoaoBotelho
<p>The "single monopoly profit theory" is often viewed as quite counter-intuitive:</p>

<blockquote>
  <p>Leverage of market power cannot be used to profitably foreclose a rival.</p>
</blockquote>

<p>Suppose there are two products, A and B. A is monopolised and produced only by firm 1; B is supplied competitively by both firm 1 and firm 2. Common sense presents to following concern: firm 1 might try to use its market power in A to become a monopolist in B and foreclose competition from firm 2. One way to do this would be to bundle A and B1 together. Everyone who buys A would also be forced to buy B1, even if B2 were the better product. This would make it difficult or impossible for 2 to achieve any sales.</p>

<p>This logic is flawed, as the Chicago school pointed out. Suppose consumers will pay $v$ for A, $v$ for B1, or $v+\Delta$ for B2 (so $\Delta$ is firm 2's quality advantage). Suppose that A and B1 are bundled and that consumers buy the bundle. In a desparate attempt to win business, 2 will cut the price of B2 to zero (this is the usual Bertrand logic). Thus, consumers will buy the bundle if
$$2v-p_1\geq v+\Delta\implies p_1\leq v-\Delta.$$</p>

<p>Thus, the best 1 can do through bundling is to earn $v-\Delta$ from each sale of A and B1. But it could do better simply by selling A at a price of $v$ and giving $B_1$ away for free. Thus, the claim that bundling/leverage of market power is a profitable way to foreclose competition turns out to be logically flawed.</p>

<hr>

<p>Addendum: subsequent work has shown that leverage of market power is possible in various situations. But the conditions needed for it to work are more intricate than suggested by common intuition.</p>

CC BY-SA 4.0
2023-01-13T09:28:27.003Z
@user253751 Yes, good observation! If A is "essential" (as we usually say in the literature) then the argument changes slightly, but the end result is the same. 

Under bundling, if A is essential, then the only relevant options are to buy the bundle or to buy nothing at all and get a utility of zero. So that most that can be charged for the bundle is $2v$. But firm 1 could guarantee itself a profit of $2v$ without bundling by charging $2v$ for A and $0$ for B1. So, again, bundling doesn't help the firm.
Ubiquitous
CC BY-SA 3.0
2018-03-15T12:52:53.700Z
2018-03-15T12:52:53.700Z
Ubiquitous
<p><strong>It is impossible to beat financial markets.</strong> There is clearly a huge variation in views on how literally one can take this assertion and on how informationally efficient financial markets are, but almost all economists would agree that reading books on &quot;the spectacular new trading system Wallstreet does not want you to know&quot; and getting investment tips from financial analysts on TV or YouTube is a colossal waste of time.</p>

CC BY-SA 4.0
2021-02-12T14:03:39.567Z
2021-02-12T14:03:39.567Z
Michael Greinecker
<blockquote>
  <p>''Diamond Paradox'' by <a href="http://cemi.ehess.fr/docannexe/file/2360/diamond.pdf" rel="nofollow noreferrer">Diamond (1971)</a></p>
</blockquote>

<p>This is a "less-known paradox," usually put as a counter to famous Bertrand paradox. It is a starting point in the literature on informational frictions in consumer markets, and the scientists in the field agree on its significance.  </p>

<p>Its idea is diametrically opposite to that of Bertrand.  Consider the following simple example.  There are $2$ firms which produce homogeneous goods at zero marginal cost and compete in prices, $p$.  This simultaneously set prices.  Also there is a single consumer who supplies a demand given by $1-p$.  Importantly, the consumer does not observe prices set by firms and, therefore, needs to search for them sequentially, where search is costly.  Suppose that cost of visiting a firm is given by $0 &lt; c \leq \frac{1}{2}$.  Then, the unique equilibrium of the market is that both firms charge monopoly price 
$$p^M= \frac{1}{2}.$$</p>

<p>This is a diametrically opposite result to that of Bertrand. </p>

<p>The reasoning behind the result is as follows.  Suppose both firms charge $p=0$. Then, the consumer randomly visits one of the firms, say firm $i$, and buys. However, firm $i$ could have charged $c$ and made positive profits as the consumer would have bought goods anyway because she would have suffered cost $c$ had she left firm $i$ in order to buy from the rival firm.   By the same argument, one can see that $p=c$ cannot be an equilibrium as now firm $i$ can charge $c+c$ and improve its profit.  Continuing this way, it is easy to arrive to an equilibrium where both firms charge $p^M$.  A firm does not want to charge $p^M+c$ simply because its profit is maximized at $p^M$.</p>

<blockquote>
  <p>Formal Analysis of the Example</p>
</blockquote>

<p><strong>Timing:</strong> First, the firms simultaneously set prices.  Second, the consumer without knowing prices engage into sequential search.  The first search is free and the consumer visit each firm with equal probability. The consumer can come back to the previously searched firm for free.  The consumer has to observe a price of a firm to buy goods from that firm. </p>

<p><strong>Beliefs:</strong> In equilibrium, the consumer has correct belief about strategies of firms. If, upon visiting a firm, she observes a price different from an equilibrium one, the consumers assumes that the rival firm has deviated to the same price too.  Thus, the consumer has symmetric (out-of-equilibrium beliefs).  Note: the results of the game does not change if the consumers has passive beliefs.</p>

<p><strong>Strategies:</strong> Strategies of the firms are prices.  As mixing is allowed, let $F(p)$ represent the probability that a firm charges a price no greater than $p$.  Strategy of the consumer is whether to search for the second price, upon observing the first one. This strategy is given by a reservation price $r$, such that upon observing a price lower than $r$ she buys outright, upon observing a price greater than $r$ she searches further, and upon observing a price equal to $r$ she is indifferent between buying immediately and searching further.</p>

<p><strong>Equilibrium Notion:</strong> Concept of Perfect Bayesian Equilibrium (PBE) is employed.  A PBE is characterized by price distribution $F(p)$ for each firm and the consumer's reservation price strategy given by $r$ such that $(i)$ each firms chooses $F(p)$ that maximizes its profit, given the equilibrium strategy of the other firm and the consumer's optimal search strategy, and (ii) the consumer searches according to the reservation price rule $r$, given correct beliefs concerning equilibrium strategies of firms.</p>

<p><strong>Theorem:</strong> For any $c&gt;0$, there exists a PBE characterized by triple $(p^M, p^M, r)$, where $p^M$'s are charged with probability $1$ and 
$$r=1.$$</p>

<p><strong>Proof:</strong> First, I prove that $r=1$, or that the consumer buys outright when she observes any price lower than $1$.  Clearly, if she observes a price greater than $1$ she does not buy from that firm as this yields a negative payoff to the consumer.  Now, suppose she observes price $p'&lt;r$.  Then, she expects the rival firm to charge $p'$ too. Thus, if she buys outright her payoff is $\int_{p'}^{1}(1-p)dp$, and if she searches she expects a payoff equal to $\int_{p'}^{1}(1-p)dp - c$.  As the former is greater than the latter, she better-off when she buys immediately.  This proves that $r=1$.</p>

<p>Next, I prove that both firms charge $p^M$. Clearly, firms never charge above $1$ as they will never sell.  Then, the expected profit of a firm is $\frac{1}{2}(1-p)p$ because the consumer visits a firm half of the time. It is easy to see that the profit is maximized at $p^M$. <strong>QED.</strong></p>

CC BY-SA 4.0
2018-07-19T10:47:30.473Z
@denesp I'm afraid there is no textbook that I'm aware of where the paradox is discussed.  You can find short analysis of its some forms in papers on search.
Green.H
CC BY-SA 4.0
2018-07-18T14:02:11.667Z
2018-07-19T10:44:57.650Z
2018-07-19T10:44:57.650Z
Green.H
<p>Nice question! I would like to add a few elusive ones that I think are important.</p>

<p><a href="https://en.wikipedia.org/wiki/Natural_selection" rel="nofollow noreferrer">Natural selection</a> does not require intelligence. It is more of a biology theory, but its economic implications are vast. <a href="https://en.wikipedia.org/wiki/The_Evolution_of_Cooperation" rel="nofollow noreferrer">Evolution of cooperation</a> is very useful but often ignored by economists and politicians as it goes against some common sense rules.</p>

<p>The entire theory of probability is counter-intuitive and has plenty of traps in economics for those who use only common sense. One example is a <a href="https://en.wikipedia.org/wiki/Monty_Hall_problem" rel="nofollow noreferrer">Monty Hall paradox</a>: once you made your decision with limited information, you will gain by changing your decision when you get more information. A common fallacy of "throwing good money after bad" stems from ignoring this principle. Literally everyone has been guilty of it.</p>

CC BY-SA 3.0
2018-03-18T10:19:59.197Z
The biological examples are nice, but explaining them would greatly improve this answer.
"throwing good money after bad" has nothing to do with Monty Hall. It is a coping mechanism for the cognitive dissonance arising from having made a bad decision.
Giskard
CC BY-SA 3.0
2018-03-18T07:41:59.307Z
2018-03-18T07:41:59.307Z
Arthur Tarasov
<p><strong>Price control hurts consumers.</strong></p>
<p>So called price gouging is a specific example. Most states even have price gouging laws, which limit how fast price for some consumer goods can increase. And it is very common to hear complains from both laymen and not-so-laymen about price surge and &quot;speculation&quot;.</p>
<p>Price is an equilibrium outcome, which equalizes demand and supply. In other words, market price is a price, at which quantity supplied is exactly equal to quantity demanded. So what happens when the price is restricted below its market level? Shortage. At such price demand outstrips supply, so we see empty shelves.</p>
<p>There are two main negative consequences of anti-price gouging laws. First, consumer surplus decreases, since the product is consumed not by consumers, who value it the most, but by consumers, who happen to buy it when it is available.</p>
<p>Second, and the most important one, is that supply will not adjust to accommodate rising demand. Without price control, high prices imply increased revenue of producers, incentivizing them to ramp up production fast. So after a while supply increases and equilibrium price falls. Under price control no increase in supply is possible, since it is not profitable for producers. So the shortages will last up to the point when demand shock passes. If demand shock is permanent, then shortage will be permanent too.</p>

CC BY-SA 4.0
2023-02-02T15:30:16.903Z
@user253751 Your argument works only statically if you fix supply at a constant level. No matter how large the preference for random allocation your social welfare function could imply, an increased supply from extra incentives to producers would always outweigh it after some time. You can consume only what is produced.
Moysey Abramowitz
CC BY-SA 4.0
2021-09-05T00:35:16.850Z
2021-09-05T00:43:17.653Z
2021-09-05T00:43:17.653Z
Moysey Abramowitz
<p>The best answer to this question has to be pricing. It is agreed in economics that pricing reflects the supply and demand and it depends on these on a free market. Still, you'd often hear people how some product is too expensive because it is just some <em>raw material</em> plus some <em>working hours</em>.</p>

<p>Even worse, you sometimes see business owners billing their service or products by some amount of material and some hours of labour. For e.g. a carpenter who sells some closet for 1.2 cubic meter of wood at 800\$/cubic meter + 30 hours of work at 90\$ per hour, giving a grand total of nobody cares. Because if someone comes in and says I want that closet for 1 million euros and you're willing to give it for that money, that's PRECISELY what it's worth. Exactly in the same way as if someone comes in and wants to pay you 100 euros for the closet, you can't claim it's worth at least the material+labour, because nobody is willing to pay that money, so it's not worth that much, but PRECISELY 100 euros.</p>

<p>In a nutshell, it is a consensus in Economics that prices are driven by supply and demand on free market, but for some reason people very widely believe that it's common sense that prices are driven by production costs.</p>

CC BY-SA 3.0
2018-03-14T20:39:02.013Z
uhm have you ever sat in a micro lecture? Because most of that is arguing that in equilibrium on a competitive market prices will be equal to costs. Because if it is above cost you will have entry and below cost firms will close. Which means you end up with prices at cost. And this makes markets efficient. If everyone who has higher utility from the product than it costs gets it, aka when the price equals cost, then you get a pareto optimal outcome. Effectively when considering a product, you consider if the value it provides is higher than the cost it causes (the price).
Felix Benning
CC BY-SA 3.0
2018-03-15T13:34:39.163Z
Actually, the price is equal to the marginal cost of production in any efficent market.
Repmat
CC BY-SA 3.0
2018-03-15T13:59:03.773Z
@FelixB. and repmat Both of you made my point. People noticed that there is somehow a correlation between production costs and prices, and immediately assume that prices must be driven by production costs, which is something economists agree it is not true. It's as if you're watching a carriage with a horse and deduce that the carriage must push the horse further, since they're both going at the same speed.
Andrei
CC BY-SA 3.0
2018-03-15T18:57:09.160Z
@Andrei but you complain about "you'd often hear people how some product is too expensive because it is just some raw material plus some working hours" and if you agree, that in a competitive market the price should be marginal cost, then you also have to agree that if it is not at marginal costs, there is a market failure and the people are right to complain about the wrong prices. So it is a fine thumb rule to consider the costs.
Felix Benning
CC BY-SA 3.0
2018-03-17T05:32:10.740Z
If something has a low cost to produce and is selling for a high price, probably somebody else will notice and start making their own and sell it for a lower price (either to undercut the other guy or because of the increased supply to demand ratio). Production costs determine how low the price can go in such a situation. Furthermore, if somebody spends \$1 to make something and tries to sell it for \$100, he may have a hard time finding a buyer if the public is aware of the low production cost. This generally lowers the price.
Kef Schecter
CC BY-SA 3.0
2018-03-17T13:39:56.803Z
You are all literally making my point. You just don't get how the market works and you're also not reading the answer. Any price is simply an agreement between the buyer and the seller. None of you answered why wouldn't a transaction happen when the production costs and the price are far off, if the buyer and the seller agree. All of you suggest that that can't happen when it is happening everyday. See cpu prices, airplane first class seats, fashion, etc... I am actually glad that I have the lowest score on this answer, as it stands as proof that it's something easy, yet nobody gets it
Andrei
CC BY-SA 3.0
2018-03-18T11:38:14.137Z
Lets's split this into two cases: 1. You make a descriptive statement: "Prices in a free market are determined by supply and demand". This is true, but no one disputes that, it is also common sense. What people dispute whether prices _should_ be determined by supply and demand. So Case 2: You make a normative statement: "Prices should only be determined by supply and demand". And that would be wrong, because for pareto-efficiency you want prices to be at marginal costs. If markets work, then those coincide. If markets fail then prices _should_ still be at marginal costs.
Felix Benning
CC BY-SA 3.0
2018-03-24T01:29:54.590Z
@FelixB. Life is not a game and not even the cruelest dictators can tell the market how to behave. The expressions "prices should be" or "you want prices to" do not even make sense in real life. What is the point to discuss what you want prices to be when that is a provable impossibility?
Andrei
CC BY-SA 3.0
2018-03-24T22:50:49.260Z
Because you need prices to be at marginal costs for your economy to be even pareto efficient (which is such a weak requirement that everyone would agree is the minimum that we should strive for). And yes you can set price ceilings as a state. And in case of monopolies that sometimes makes sense.
Felix Benning
CC BY-SA 4.0
2018-05-20T04:41:30.590Z
@Andrei The quantity supplied is dependent on the price customers are willing to pay.  If it costs me 200 dollars to make a carriage and customers are only willing to pay 100 dollars for a carriage, then I simply will not make the carriage.  It's only if the customer is willing to pay more than 200 dollars that I will be willing to make the carriage.  So my costs of producing the good are highly relevant to whether the good gets produced, and thus the price the good is sold at.
Keshav Srinivasan
CC BY-SA 3.0
2018-03-14T16:21:34.537Z
2018-03-14T16:21:34.537Z
Andrei
<p>What are some results in Economics that are both a consensus between most economists and far from common sense? </p>

<p>I would also welcome suggestions of clear definitions for what we should mean as <em>consensus</em> , specially considering that economics is an area with a lot of methodological divergence. Let me try first, a suggested definition for <em>consensus</em> in this setting would be:</p>

<blockquote>
  <p>the existence of a group of experts that would claim that the result
  is certainly true.</p>
</blockquote>

CC BY-SA 3.0
2018-03-13T18:59:43.233Z
I was expecting to see an answer with "markets are efficient".  I'm honestly unsure if it's not there because of a lack of consensus or not there because economists have unusual notions of common sense.
psr
CC BY-SA 3.0
2018-03-14T08:14:59.027Z
@psr Because "markets are efficient" only if all the requirements for the welfare theorems to work are met. Introduce externalities, private information, transaction costs, fix costs, etc. and suddenly you end up with something not efficient at all. In most situations not all of those requirements are met. But in a lot of situations it is also hard to do better than the market. Then there a bunch of situations where you can internalize externalities with some intervention, etc. So it really depends on the situation
Felix Benning
CC BY-SA 3.0
2018-03-14T11:09:49.800Z
The problem is probably the definition of common sense here.
NoDataDumpNoContribution
CC BY-SA 3.0
2018-03-14T13:21:45.093Z
Not precisely economics, but closely related and of likely interest to the asker: The Monty Hall Paradox. There are three doors; one has money behind it and the other two have something worthless. You pick door #1; and have a 1/3 chance of getting the money. Monty then opens up door #2, revealing one of the worthless prizes, and asks if you want to stay with the door you picked or switch to door #3.  “Common sense” says your odds are 50/50; but that’s wrong. Remember when your door had a 1/3 chance?  That hasn’t changed.  You should take door #3 because there’s a 2/3 chance that has the money.
Stephen R
CC BY-SA 3.0
2018-03-14T18:45:46.440Z
The law of unintended consequences is common knowledge in economics. It is not exactly far from common sense, but it is very often (incl. willfully) forgotten or ignored in economic (or pseudo-economic) analysis. I understand this law to mean that any coercive or involuntary economic action is incrementally destructive; if the action was taken under the pretext of a common good, it will have unintended consequences. There are other, similar formulations of this law.
Jake
CC BY-SA 3.0
2018-03-14T19:00:42.413Z
@StephenR What if I pick door #1, you pick door #3, and door #2 is then opened to reveal a worthless prize? We would both have to switch our choices: for me, there would be a 2/3 chance that door #3 has the money, and for you, it would be door #1. However, the probability of the money being behind a door is objective, so there is a contradiction. What do you think?
Jake
CC BY-SA 3.0
2018-03-14T20:37:25.713Z
@Jake -- It's a great question. The dissonance surrounding the Monty Hall paradox is the distinction between Monty picking a door at random, or doing so *with knowledge*. Monty knows which door has the cash, and deliberately chooses the door that does NOT.  You choosing one of the other doors forces Monty's hand, and thus changes the equation.  It becomes easier to grasp if you change it to 100 doors, you pick one, and Monty opens 98 of them with worthless prizes....
Stephen R
CC BY-SA 3.0
2018-03-14T21:22:21.513Z
@FelixB.The less complete information is, the more attempting to improve efficiency with central planning fails, because the planners themselves have less information than the market in aggregate has.  Prediction markets have repeatedly shown themselves more accurate than the best experts.
Monty Harder
CC BY-SA 3.0
2018-03-14T21:25:51.657Z
@Jake Any voluntary economic transaction can only take place when all parties believe it benefits them.  That coerced transactions can lead some or all parties to believe they've been left with less is orthogonal to the Law of Unintended Consequences.  The latter is simply the observation that privileging alleged intent over actual results of various behaviors tends to lead to behavior that produces really bad unintended consequences.  Put simply, if you didn't take those consequences properly into account in making the decision, you're likely to choose sub-optimally.
Monty Harder
CC BY-SA 3.0
2018-03-15T07:58:32.193Z
"Infinite growth is possible in a finite world" seems to be a consensus. It's also far from common sense, because, well, it *is* wrong.
Eric Duminil
CC BY-SA 3.0
2018-03-16T11:26:09.087Z
@MontyHarder yes incomplete information often leads to markets being better than planners as I said: "But in a lot of situations it is also hard to do better than the market." But depending what information is private it can still lead to an inefficient outcome. (e.g. Market for Lemons). "Markets are efficient" is just a complete oversimplification.
Felix Benning
CC BY-SA 3.0
2018-03-16T13:24:55.650Z
You should read the introduction and first chapter of "Capital in the XXI Century" from Thomas Piketty. It makes a wonderful criticism at the consensus in Economics.
JoaoBotelho
CC BY-SA 3.0
2018-03-16T13:40:56.067Z
"In economics, the real world is always a corner case. -*Douglas Allen*.
Cloud
<reference-request>
What are some results in Economics that are both a consensus and far from common sense?
psn
# What are some results in Economics that are both a consensus and far from common sense?

(Asked by: username_0 on 2018-03-12)

What are some results in Economics that are both a consensus between most economists and far from common sense?

I would also welcome suggestions of clear definitions for what we should mean as *consensus* , specially considering that economics is an area with a lot of methodological divergence. Let me try first, a suggested definition for *consensus* in this setting would be:

> the existence of a group of experts that would claim that the result
> is certainly true.

**Tags:** reference-request
> **Comments:**
> **username_1**: I was expecting to see an answer with "markets are efficient".  I'm honestly unsure if it's not there because of a lack of consensus or not there because economists have unusual notions of common sense.  
> **username_2**: @psr Because "markets are efficient" only if all the requirements for the welfare theorems to work are met. Introduce externalities, private information, transaction costs, fix costs, etc. and suddenly you end up with something not efficient at all. In most situations not all of those requirements are met. But in a lot of situations it is also hard to do better than the market. Then there a bunch of situations where you can internalize externalities with some intervention, etc. So it really depends on the situation  
> **username_3**: The problem is probably the definition of common sense here.  
> **username_4**: Not precisely economics, but closely related and of likely interest to the asker: The Monty Hall Paradox. There are three doors; one has money behind it and the other two have something worthless. You pick door #1; and have a 1/3 chance of getting the money. Monty then opens up door #2, revealing one of the worthless prizes, and asks if you want to stay with the door you picked or switch to door #3.  “Common sense” says your odds are 50/50; but that’s wrong. Remember when your door had a 1/3 chance?  That hasn’t changed.  You should take door #3 because there’s a 2/3 chance that has the money.  
> **username_5**: The law of unintended consequences is common knowledge in economics. It is not exactly far from common sense, but it is very often (incl. willfully) forgotten or ignored in economic (or pseudo-economic) analysis. I understand this law to mean that any coercive or involuntary economic action is incrementally destructive; if the action was taken under the pretext of a common good, it will have unintended consequences. There are other, similar formulations of this law.  
> **username_5**: @StephenR What if I pick door #1, you pick door #3, and door #2 is then opened to reveal a worthless prize? We would both have to switch our choices: for me, there would be a 2/3 chance that door #3 has the money, and for you, it would be door #1. However, the probability of the money being behind a door is objective, so there is a contradiction. What do you think?  
> **username_4**: @Jake -- It's a great question. The dissonance surrounding the Monty Hall paradox is the distinction between Monty picking a door at random, or doing so *with knowledge*. Monty knows which door has the cash, and deliberately chooses the door that does NOT.  You choosing one of the other doors forces Monty's hand, and thus changes the equation.  It becomes easier to grasp if you change it to 100 doors, you pick one, and Monty opens 98 of them with worthless prizes....  
> **username_6**: @FelixB.The less complete information is, the more attempting to improve efficiency with central planning fails, because the planners themselves have less information than the market in aggregate has.  Prediction markets have repeatedly shown themselves more accurate than the best experts.  
> **username_6**: @Jake Any voluntary economic transaction can only take place when all parties believe it benefits them.  That coerced transactions can lead some or all parties to believe they've been left with less is orthogonal to the Law of Unintended Consequences.  The latter is simply the observation that privileging alleged intent over actual results of various behaviors tends to lead to behavior that produces really bad unintended consequences.  Put simply, if you didn't take those consequences properly into account in making the decision, you're likely to choose sub-optimally.  
> **username_7**: "Infinite growth is possible in a finite world" seems to be a consensus. It's also far from common sense, because, well, it *is* wrong.  
> **username_2**: @MontyHarder yes incomplete information often leads to markets being better than planners as I said: "But in a lot of situations it is also hard to do better than the market." But depending what information is private it can still lead to an inefficient outcome. (e.g. Market for Lemons). "Markets are efficient" is just a complete oversimplification.  
> **username_8**: You should read the introduction and first chapter of "Capital in the XXI Century" from Thomas Piketty. It makes a wonderful criticism at the consensus in Economics.  
> **username_9**: "In economics, the real world is always a corner case. -*Douglas Allen*.  

---

## 19 answers

### Answer by username_10 on 2018-03-13. Score: 46

Most theorems in economics would satisfy the consensus requirement. However, depending on what you consider to be common sense, different results will qualify. The following are two results that I found sufficiently hard to believe when I first encountered them.

---

The [**revenue equivalence theorem**](https://en.wikipedia.org/wiki/Revenue_equivalence), which, according to Wikipedia, implies that

> any single-item auction which unconditionally gives the item to the highest bidder is going to have the same expected revenue.

---

[**Arrow's impossibility theorem**](https://en.wikipedia.org/wiki/Arrow%27s_impossibility_theorem), which, according to Wikipedia, suggests that

> no rank-order electoral system can be designed that always satisfies these three "fairness" criteria:
>
> * If every voter prefers alternative X over alternative Y, then the group prefers X over Y.
> * If every voter's preference between X and Y remains unchanged, then the group's preference between X and Y will also remain unchanged (even if voters' preferences between other pairs like X and Z, Y and Z, or Z and W change).
> * There is no "dictator": no single voter possesses the power to always determine the group's preference.

> **Comments:**
> **username_10**: @Servaes: Why not? The result was first published in the *Journal of Political Economy*, an economics journal, and Arrow worked on the problem while completing his PhD in --- guess what --- *economics*.  
> **username_11**: Without additional context, the description of the "_revenue equivalence theorem_" seems to imply that auction prices are independent of the item being auctioned, e.g. that a single-item auction for a toothpick would have the same expected revenue as an auction for a yacht, along with other absurdities.  Presumably these absurdities are prohibited, but if so, what seemingly absurd conditions are allowed such that the theorem's counter-intuitive?  
> **username_12**: @Servaes: Moreover, Arrow's theorem concerns the problem of preference aggregation, which is well within the scope of economics.  
> **username_6**: @Ben How does economics cover voting?  It's not like "consumers" can somehow earn more votes to "spend" on their preferences, perhaps by "saving" a vote and "investing" it in something that will produce more votes in the future. It's common for nearly half the voters to "spend" their votes and get absolutely nothing in return (having not voted for the winning candidate).  
> **username_10**: @MontyHarder: Your thinking is a typical misconception of economics. Of course voters, i.e. consumers of politics, have preference over policy platforms. While most voters are by birth endowed with the right to vote, many others such as immigrants incur high costs in order to "purchase" the right to vote as citizens in a democratic society. The cost-benefit analysis you described at the end is well known among economists as the [paradox of voting](https://en.wikipedia.org/wiki/Paradox_of_voting).  
> **username_12**: @Monte Harder: The problem of voting systems is a part of the broader study of [social choice theory](https://en.wikipedia.org/wiki/Social_choice_theory), which is generally considered to form a part of economics.  This latter theory studies the mathematical properties of functions that attempt to aggregate a set of preferences (e.g., n utility functions) into a single "social preference" (i.e., one utility function) or "social choice" (i.e., one outcome).  
> **username_13**: @Nat the additional context is given in the link. For a *fixed item*, but *variable type of auction*, the expected revenue is, given certain conditions, fixed. You seem to think that "any auction" means "auctioning off any item", when it instead means "any method of auctioning the item in question".  
> **username_11**: @Acccumulation The issue isn't my personal understanding but rather making the post complete.  The phrase "_any auction_" means just that: _any auction_.  If it's to be used above, it should be appropriately qualified.  And to clarify, the constraint on it being for the same item was just one example of a constraint that'd need to be stipulated; there're a lot of others.  
> **username_11**: @Acccumulation Just so I don't come off the wrong way, not trying to be excessively pedantic here or anything.  My concern was just that, by itself, the quote's very misleading.  That theorem's true only in very idealistic models.  But since this is a question about theorems that seem counter-intuitive, it'd be nice to have a statement of when it does apply, to highlight how it might be counter-intuitive in those cases.  I mean, it seems highly counter-intuitive in the general case, but that's actually good because it's not true in the general case.  
> **username_6**: @HerrK. To "purchase" the right to vote is not the same thing as to cast that vote and thus "purchase" some good or service from a supplier thereof.  It's hardly a "misconception of economics" to insist that some semblance of what defines economic transactions relate to the situation you're trying to call "economics"  It's precisely because those who vote for a non-winning candidate get nothing in return for the effort they expend that the normal rules of economics are difficult to apply.  
> **username_14**: @MontyHarder what are the "rules of economics"? A large part of economics is about the allocation of scarce resources. Votes are a scarce resource. So is the choice of candidate/party/policy in an election.  

---

### Answer by username_15 on 2018-03-13. Score: 30

In an open economy, [**the balance of payments current account equals net saving**](https://en.wikipedia.org/wiki/Saving-investment_balance). This is often represented as:

$$S - I = X - M$$

where $S$ is saving, $I$ is investment, $X$ is exports and $M$ is imports.
That is admittedly a slight over-simplification as current account includes not only exports and imports of goods and services but also other items such as income from foreign investments or employment abroad, and foreign aid. For many countries, however, the net amount of these other items is relatively small so that the balance on trade in goods and services approximates fairly closely to net saving.

This appears to diverge from common sense since, if a country has a trade deficit, most non-economists looking for explanations will consider possibilities such as:

* lack of competitiveness of domestic firms;
* 'dumping' by foreign producers;
* 'unfair' international trade agreements;
* an overvalued exchange rate.

Very rarely will a non-economist suggest that a trade deficit has anything to do with levels of saving and investment.

Note that saving and investment here include those of both the private and the government sectors. So one implication of the above is that a government deficit, unless offset by private sector net saving, will be associated with a trade deficit (just 'associated' because the direction of causation is a further question).

> **Comments:**
> **username_16**: It seems common-sensical enough that the trade surplus - being the amount of money your country has made from selling stuff that it hasn't yet used to buy stuff - would be equal to the total savings in the country since on an individual level that is the definition of savings...  
> **username_16**: Also all of the above factors would seem to ultimately relate to income and expenditure, which relate to savings.  
> **username_15**: @immibis Your comments appear to be based on an introspective approach to common sense ("this is how it seems to me").  And certainly this is not a proposition that needs advanced maths to be proved.  My point is that it isn't commonsensical in the sense that non-economists rarely show understanding or awareness of it.  
> **username_16**: I wonder if it's just because nobody wants to think about the prospect of spending less money.  
> **username_17**: Can you edit this to say what S, I, X, and M stand for?  
> **username_18**: This only seems to mean that countries with a trade surplus will have to put this surplus somewhere ... Moreover, this balance theorem doesn't answer the cause of trade deficit, while the 4 allegedly stupid explanations do.  
> **username_15**: @curiousdannii  Done!  
> **username_15**: @agemO  I'm not suggesting that the 4 explanations are stupid, only that they are not the whole picture.  

---

### Answer by username_19 on 2018-03-13. Score: 27

The **Giffen Paradox** - increasing prices can lead to higher demand even if the goods are considered inferior.

General consensus is increasing prices lead to less demand - if it's more expensive, people will buy less.

In some cases, increasing the price will make consumers perceive a good to be of higher quality, or more desirable, thereby increasing demand. (Example - if iPhones cost only one third of what they do, nobody would spend their money on a phone that doesn't even run Android).

However, even with inferior goods, rising prices can lead to higher demand. This paradox was first observed by Giffen in the 19th century, when rising potato prices meant poorer people weren't able to afford the occasional egg or piece of meat anymore, buying more potatoes instead.

> **Comments:**
> **username_19**: This could possibly be called an "observation" more than a "result", but it's something that's easy to comprehend once you read the explanation, but hard to wrap your head around without an example.  
> **username_17**: Depending on who you talk to, an iPhone might be a perfect example of an inferior good ;)  
> **username_20**: This is similar to the response of thrifty savers to falling interest rates: "We better save more to compensate!" Which thwarts political efforts to stimulate spending.  
> **username_21**: For many years the real world evidence of Giffen goods was very poor. The evidence from potatoes in the 19th century is discredited. I believe Battalio, Kagel , Kogut (1991) are the first to provide hard evidence, from experiments. We didn't get real world evidence until Jensen and Miller (2008). Most people who believe in Giffen goods probably do so based on low quality or falsified "evidence".  

---

### Answer by username_22 on 2018-03-13. Score: 24

1. The fact that the burden of a tax on sellers can by borne by buyers, and vice versa. More generally, the fact that true tax incidence is largely or completely unrelated to who is nominally being taxed (e.g. taxes on yacht purchases can in principle hurt the poor more than the rich, etc.).
2. The fact that in a perfectly competitive market with free entry and exit, all firms make zero profits in the long run (if opportunity costs are taken into account).
3. [Coase's theorem](https://en.wikipedia.org/wiki/Coase_theorem): "if trade in an externality is possible and there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property". (E.g. under a cap-and-trade system for pollution permits with sufficiently low transaction costs, the final allocation of permits is independent of the initial allocation, even if some permits are sold and others are arbitrarily given away for free.)
4. This one's a bit more "in the weeds", but the difficulty of eliminating the [marriage penalty](https://en.wikipedia.org/wiki/Marriage_penalty): "it is mathematically impossible for a tax system to have all of (a) marginal tax rates that increase with income, (b) joint filing with income splitting for married couples, and (c) combined tax bills that are unaffected by two people's marital status."

> **Comments:**
> **username_23**: Any link to explain nr 1? It sounds completely counterintuitive  
> **username_24**: I am guessing because sellers can 'pass on' the cost of taxes to their buyers via increased price, with equivalent processes working the other way, and this passing on of cost propagating through an economy is how yacht purchase tax could theoretically land on people far removed from yacht buyers?  
> **username_22**: @benxyzzy I wasn't thinking it would land on people "far removed" from yacht buyers, but rather on yacht manufacturers. If the demand for yachts is much more elastic than the supply, then a large tax on yacht purchases would cause the before-tax price to drop much further than the after-tax price rises, so that the wealthy purchasers are only affected modestly, but the (probably poorer) manufacturers get hit really hard.  
> **username_20**: I'm calling foul since this proposes 4 different ideas, with different levels of detail. Also, #2 is especially arguable since it is about an impossibly idealized theoretical situation populated by mindless actors (i.e. in the real world, not all actors choose to enter all profitable markets, and the smart early-entry firms should not stick it out in the face of decreasing-profits.)  
> **username_25**: @MarkHu As for #2, "the long run" is the key phrase. You will eventually reach a zero-profit equilibrium *if there's no innovation or change in demand etc.*. With change, the market does tend towards this equilibrium, but the target keeps moving and is never really reached (and in a tiny proportion of the cases, never even gets close). But if you look at the average, there's very little profit in the *bulk* of human trades - don't get yourself distracted by the few outliers (and state-granted monopolies). Not perfect, but not a fairy tale either.  
> **username_23**: @tparker Wouldn't that require that yacht manufacturers are locked into manufacturing only yachts? Are we talking people or companies here?  
> **username_22**: @JollyJoker Sales taxes hurt yacht manufacturers whether or not they're locked into the industry. If they choose to keep selling yachts, they're hurt by the forgone sales and lower after-tax sale price. If they choose to go into other industries, they increase the supply of labor in those other industries and therefore push down the wage. The same argument holds for buyers, with "supply", "down", and "wage" replaced by "demand", "up", and "price" respectively. If this weren't the case, then the government could use targeted sales taxes as a free lunch for raising revenue without harming anyone  
> **username_26**: I guess for 4., you could just allow joint filing (+ income splitting) for non-married couples too ;-)  
> **username_27**: #4 isn't in the "counterintuitive but true" category; rather, it's in the "summary is false, full explanation is obvious" category. It's easy for a tax system to eliminate the marriage penalty, either by allowing married partners to file as if they were both single, or by setting the tax bracket thresholds for married couples at double the corresponding thresholds for single people.  
> **username_28**: @ruakh, your "setting the tax bracket thresholds for married couples at double the corresponding thresholds for single people" proposition won't work if the married people have different incomes and tax bracket is progressive. It's straightforward to show that the only tax scheme that satisfy b and c and has overall (although not marginal) tax rate increasing with income is T=A*income-B, where T is tax amount, A is fixed percentage, and B is fixed amount.  
> **username_27**: @Michael: I think you must have misread my comment somehow. (Specifically, I think you must have missed the first sentence . . .) My solution that you quote works perfectly for "eliminating the marriage penalty" in exactly the situation you describe; it's true that it doesn't "satisfy b and c" (specifically: it doesn't satisfy c), but neither b nor c is a requirement for "eliminating the marriage penalty".  
> **username_29**: On 2, surely that's just a particular case of the more general rule that in a perfectly ideal market the expectation value of any security or speculative investment is the same, which is counterintuitive, obvious with a bit of thought, and completely irrelevant because no such markets have ever existed  

---

### Answer by username_30 on 2018-03-15. Score: 16

Best price clauses and, to a lesser extent, price-matching guarantees have been the subject of intense regulatory activity in recent years. Here's a fact that is surprising to many, despite there being a significant consensus in the economics profession:

> Best price clauses and price-matching guarantees can harm competition and consumers

---

A **best price clause**/most favored nation clause/price-parity clause requires a seller listing a price via one venue (e.g. a price comparison website) to ensure that the price listed there is no higher than that available through other similar venues. It is often imposed by venue operators to ensure their venue will attract customers. Common sense suggests that a clause requiring a vendor to be offered the *lowest* available price should be, at worst, neutral for consumers.

Suppose there are two venues, $A$ and $B$, that a seller can sell through. Suppose both are large suppliers of business to sellers, so simply quitting one of the venues is not a viable option.

Here's the problem: if venue $A$ charges a commission of $c\_A$ to sellers who sell through its platform and venue $B$ charges commission $c\_B>c\_A$ then sellers will set a lower price on $A$ than on $B$ to try to steer consumers to buy through venue $A$ (where it pays lower commission). Thus, a venue can have consumers steered towards it by cutting its commission--venues compete in commission. Moreover, lower commissions (which are essentially a variable cost for the seller) are passed-through to consumers in the form of lower prices.

Now suppose there are best price clauses in effect. If $c\_A

---

A **price matching guarantee** is a promise from a seller to a consumer of the form "If you find the same product at a lower price elsewhere, I'll beat that better price". Common sense suggests a guarantee to beat the lowest price in the market should be good for consumers. Not necessarily so.

Here's a rough illustration of why: Suppose sellers A and B both have price-matching guarantees and consumers have a preferred seller from whom they buy by default unless the other seller offers a better deal. Normally, sellers would cut their prices to try to attract consumers from their rival. But here that doesn't work! If A cuts its price then the consumers whose default is B can just go to B and get it to match A's reduced price. But this means A has no benefit from lowering its price and will just stick with the same high price that it had all along. The price-matching guarantee has completely killed price competition!

> **Comments:**
> **username_31**: Isn't this *exactly* common sense? Why else would sellers use price matching guarantees rather than actually lowering prices?  
> **username_30**: @mattdm Well, one could easily tell a story about consumers who face search or shopping frictions and therefore can't be sure where the lowest market price is (or firms that can't perfectly monitor rivals' prices and sometimes end up charging more than rivals by mistake). Such a guarantee would then plausibly be beneficial for consumers. In any case, it was a big battle for economists to get competition policy makers (who are more informed than the general public) to see the potential equilibrium harm of these things, suggesting that it's not that common sense.  
> **username_16**: If the price is the same at A and B then, unless there's a *pretty big difference* in customer service etc, I'll just buy the product from whichever one I happen to visit second. Which, actually, might be the worse one, if I'm in the habit of checking my preferred store first. Otherwise I have to go back to the first store.  

---

### Answer by username_36 on 2018-03-15. Score: 13

I’m going to toss my hat into the ring with *the very notion of*

# Opportunity Cost

Who hasn’t argued with someone who “likes” A, which has an opportunity cost B, and have that person adamantly refuse to consider the loss of B as a cost for A or in any way relevant to the choice to get A? If you’ve ever tried to persist in such a situation, I’m sure you also quickly found the other person getting offended, as if you were insulting A and/or them for liking A.

A large part of the problem is, of course, the not-so-subtle verb substitution I used: the person in question here is talking about, and thinking about, “liking” A. The speaker, you or I in the hypothetical, is instead talking about the decision of whether or not to procure A. The argument is, fundamentally, that A can be good, worth “liking,” but not worth it—because of the opportunity cost B. And if anyone knows of a good way to explain that and assuage hurt emotions over feeling attacked for liking A, I’m all ears! Recognizing the problem does not itself produce a solution to it.

Anyway, unlike a lot of other issues on this page, which are important but not a daily concern, opportunity cost is, or at least could be, at the heart of just about every decision every person makes. It is relevant to all people, but a lot of people seem to not just ignore it, but to actively disdain the very concept. Therefore it seems, to me, like a strong contender here.

> **Comments:**
> **username_37**: See: Ferraro Paul J & Taylor Laura O, 2005 "[Do Economists Recognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science](https://ideas.repec.org/a/bpj/bejeap/vcontributions.4y2005i1n7.html)". The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 4(1), pages 1-14, September. (The paper is widely available and discussed elsewhere on the internet. 78% of economists gave the wrong answer to a basic multiple choice question on opportunity costs, although the wording of the question has been criticised by others.)  
> **username_37**: The question they posed was: "You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost 40 dollars. On any given day, you would be willing to pay up to 50 dollars to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) 0 dollars, (b) 10 dollars, (c) 40 dollars, or (d) 50 dollars."  
> **username_38**: @KRyan: Can I suggest you delete your comment so that others who wish to contemplate the problem on their own before looking up the answer are not influenced by your answer? There's no need to ask here if you're correct; you can find the correct answer yourself, plus the reasoning behind it, in [the paper](https://ais.ku.edu.tr/course/17404/ferrarotaylorbep.pdf).  
> **username_36**: @Curt Sure, but no I could not have done that, because Silverfish’s link wanted to charge money to access the paper.  
> **username_38**: It's always worth trying a quick web search. That's how I got the link to a free copy in my comment above. (I don't know how long it will last, which why I'm mentioning here how I found that link.)  

---

### Answer by username_30 on 2018-03-15. Score: 11

> Price discrimination can make consumers better-off

This can happen in a variety of ways. For example, suppose that 50% of consumers are 'loyal' to firm A and 50% loyal to firm B. A consumer is willing to pay $v$ for one unit and incurs a switching cost $s\in(v/2,v)$ if they buy from a firm other than the one to which they are loyal. Consumers buy from the firm offering the highest utility, breaking indifference in favour of the firm to which they are loyal.

If firms must offer the same $p$ to all consumers then, the only pure strategy equilibrium has $p\_A=p\_B=v$.

If we allow firms to price discriminate by offering different prices to loyal and non-loyal consumers then $p\_i=v$ is never an equilibrium and there is an equilibrium in which $p\_i^{\text{loyal}}=s$, $p\_i^{\text{non-loyal}}=0$.

Without price discrimination firms don't compete to attract the rival's consumers. Intuitively, it takes a price cut of at least $s$ to do so, but that means also losing $s$ units of profit from loyal consumers who also benefit from the price cut. With price discrimination, on the other hand, a firm can fight for its rival's loyal without sacrificing any profit on its own. But this goes in both firections so both firms end up having to fight for their loyals against a rival that is trying to poach them.

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Another ways that price discrimination can benefit consumers is by giving a firm enough profit to make a product viable (otherwise the product wouldn't get produced at all, leaving consumers with zero surplus).


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### Answer by username_20 on 2018-03-14. Score: 11

There is the monetary [Impossible trinity](https://en.wikipedia.org/wiki/Impossible_trinity) concept in international economics:

The impossible trinity (also known as the "trilemma" ...) is which states that it is impossible to have all three of the following at the same time:

* a fixed foreign exchange rate
* free capital movement (absence of capital controls)
* an independent monetary policy

Granted there may not be much "common sense" thinking on such an esoteric concept. But the Economist magazine thinks it is pretty important [according to *The Economist*](https://www.economist.com/news/economics-brief/21705672-fixed-exchange-rate-monetary-autonomy-and-free-flow-capital-are-incompatible). Also, more people are becoming aware of such things since the blockchain and cryptocurrency popularity surge in late 2017.

> **Comments:**
> **username_16**: Common sense tells me you can't have #1 and #3. Then you might tell me about capital controls and I might go "oh yeah, I guess that would kinda work, though it causes its own problems."  

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### Answer by username_39 on 2018-03-16. Score: 11

# [Jevons Paradox](https://en.wikipedia.org/wiki/Jevons_paradox)

Let's say current engine technology allows vehicles to go one mile on a gallon of gas. Improving engine technology to achieve 10 MPG must decrease the amount of gas used, right?

Actually it depends. Increased efficiency has two effects. One effect is that per unit of distance, less gas is consumed. Another effect is that driving one unit of distance is now cheaper, increasing travel. How much travel increases depends on how much the demand curve rises moving from the old unit price to the new unit price. In fact *travel can increase by a larger factor than efficiency increases*, leading to more fuel consumption.

> **Comments:**
> **username_15**: It would be helpful if you could include in your answer a link to a relevant source.  I was aware of this "paradox" but unaware that it had been named after Jevons.  
> **username_39**: @AdamBailey I added link.  
> **username_30**: This is conceptually related to the notion of [risk compensation](https://en.wikipedia.org/wiki/Risk_compensation).  
> **username_39**: @Ubiquitous Yes, it is, and both profoundly affect public policy...  

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### Answer by username_4 on 2018-03-13. Score: 10

**Lowering income tax rates can in some circumstances increase revenue**. A simplistic view would assume higher taxes = higher revenue, but it doesn’t account for the fact that different tax rates alter behavior. It becomes obvious when you look at the extreme end — with a 100% income tax rate, nobody would bother having a job, because they don’t get to keep any of their wages. Government income from the tax would plummet.

The overall concept is described in a theory called The Laffer Curve

> **Comments:**
> **username_15**: I've edited your first sentence to try to clarify it.  Please feel free to reverse my edit if it doesn't capture what you meant.  
> **username_16**: I don't think this is far from common sense.  
> **username_4**: I’ve often encountered people who believe the concept of the Laffer Curve to be false; that *obviously* higher tax rates increase government revenues. Pay a bit of attention to politics and you’ll see it quite often  
> **username_32**: The interesting question here is whether the "some circumstances" actually exist anywhere at present. If the circumstances don't exist, i.e. no actual current taxes can be reduced to increase revenue, then the theory is simply an abstract curiosity and common sense doesn't come into it.  
> **username_33**: The basic principle of the Laffer curve is irrefutable. However, I'm skeptical that there is a society anywhere that is actually on the high end of the curve (i.e. that would increase revenue by lowering taxes). Even Ronald Reagan's fans don't seem to talk about the Laffer curve much anymore.  
> **username_4**: It worked for Reagan just fine. We’ll see if it works for Trump; but the fact that companies are repatriating billions of overseas dollars suggests it might.  (The difficulty administrations seem to have is to *not* increase spending at the same time, but government revenues definitely went up under Reagan.)  
> **username_31**: At the very least, I don't think the idea that Reagan-era tax cuts "worked just fine" is settled consensus — https://www.washingtonpost.com/news/fact-checker/wp/2017/11/08/did-ronald-reagans-1981-tax-cut-supercharge-the-economy/?utm_term=.0922d9cd70a9  
> **username_4**: You’re article argues an entirely different point— whether those tax cuts boosted the economy. The question at hand is whether or not government revenues from the income tax went up or down. That they went up is really not a matter of opinion  
> **username_34**: @Kef Schecter The UK had income taxes of 90% during the 1950s-60s, and in the 1970s the top rate on investment income went as high as 98%. This caused the Beatles to emigrate to the USA, along with a lot of other rich but less famous individuals.  
> **username_33**: @StephenR Reagan raised taxes and closed tax loopholes after they found they didn't have a lot of money. After adjusting for inflation and population growth on top of that, it's hard to attribute any revenue gain to cutting taxes. See for instance https://krugman.blogs.nytimes.com/2008/01/17/reagan-and-revenue/  

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### Answer by username_2 on 2018-03-14. Score: 8

**(Tradeable) Permits**

The fact that you can correct for externalities with (tradeable/marketable) permits seems to be a consensus with economists. But considering the existing applications, the theory appears to be not common sense.

Example:

The EU/countries in the EU have implemented a [Carbon Emission Trading scheme](https://en.wikipedia.org/wiki/Carbon_emission_trading) while nations within the EU continue with other regulation like promotion of solar/wind, etc. When the point of a permit trading scheme is for the market to allocate the efforts to that place where you can save CO2 most efficiently. The added regulation only distorts the permit market without actually helping to reduce the CO2 produced, as the amount of CO2 produced is set by the amount of permits issued. And by funding solar, you just make permits cheaper and increase pollution in another sector.

Another quirk is, that permits are grandfathered to companies to keep the prices down, when the gifted permits result in an opportunity cost of using them (since you could sell them at the same price), making the price rise at just the same rate as if the company had bought them. The only result of grandfathering being that it gifts money to established companies, distorting the market.

To address some further concerns in the comments:

If the amount of issued permits were to high this would still be an example of policy makers not understanding the theory of permits. The thing is, either you base your CO2 reduction policy completely on permits or not at all. If you issue too many of them, then they don't have an effect and the only reduction comes from other measures so the implementation of permits is bad. But if they are actually binding (i.e. there are less permits than people want to produce) then all the other measures have no effect as they only shuffle around where the CO2 gets produced. So the implementation of other measures is bad.
In either case there seems to be a lack of understanding of how permits work.

And I also want to argue that there are not too many permits anymore, the surplus was due to the crisis in 2008. And while I would still argue that the amount issued is still too high, the price is high enough above zero, that a reduction of CO2 in one place would probably lead to an increase in a different place. But again, it does not really matter. The issue is, that they did not implement a theory in a way that it actually works properly.

> **Comments:**
> **username_20**: This answer might be clarified by using a different term than "certificate" --that word does not appear in the article at https://en.wikipedia.org/wiki/Carbon_emission_trading wiki page. Maybe simply "permits," or more descriptively "regulatory permits and fees." In which case it becomes apparent that this so-called "market" for carbon is not much different than any other system of regulation via fees and/or fines. The main feature being the explicit waiver "price" (penalty.)  
> **username_15**: Isn't the standard economists' terminology for this "marketable permits" (or "tradable permits")?   And the popular name "cap and trade"?  
> **username_35**: The example seems to be flawed. The amount of CO2 produced is **not** set by the amount of permits issued in the ETS: there's a massive surplus of permits, hence their rock-bottom price. The amount of CO2 produced in regulated sectors is significantly less than the amount of permits issued.  
> **username_20**: Maybe the economist's "consensus" is wrong, and the commoners are right. @EnergyNumbers is correct to question how closely the artificial "market" can mirror the real world. Assuming cooperation from all actors is a stretch, depending on how antagonistic they become after the new rules are imposed on them.  
> **username_2**: what do you mean by "cooperation from all actors"? If you don't buy permits when producing CO2 you will have to pay a penalty. So as long as the penalty is above that price it does not make sense to "not cooperate"  

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### Answer by username_40 on 2020-02-11. Score: 5

**It is rational to defect in the Prisoner's Dilemma**

Cooperation is socially optimal in the [Prisoner's Dilemma](https://en.wikipedia.org/wiki/Prisoner%27s_dilemma), and in this economists and non-economists typically agree. However, the rational, i.e. the *individually* optimal choice, is to defect. From the game-theoretic point of view this is trivial, since the payoffs of the Prisoner's Dilemma game make defection a strictly dominant strategy. But it is notoriously difficult to get non-economists to agree to this reasoning. After all, if both prisoners cooperate, this makes both of them better off compared to bilateral defection, so isn't this proof enough? Ken Binmore’s (2007) *Game theory: A very brief introduction* contains several different lines of reasoning people have come up with to support cooperation as the individually optimal choice; all of them flawed.


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### Answer by username_8 on 2018-03-14. Score: 3

The assumption of the rationality of the agents is a consensus on neoclassical economics and other schools, that is often badly translated to real world examples by economists, due to the difficulty of measuring utility.

The [dictator game](https://en.wikipedia.org/wiki/Dictator_game) translates this idea quite clearly: ~~game theorists~~ some economists claim humans often act “irrationally” when making offers larger than zero. Their mistake is to assume the utility outcome of the player is equal to the monetary outcome.

> **Comments:**
> **username_41**: I am a game theorist and I do not claim that. Nor would most game theorists I know.  
> **username_8**: Edited. Happy to hear that - although not the same in the 3 universities that I've studied. Even if they wouldn't write it, this would be often claimed in classes and discussions.  
> **username_41**: Thanks. I think most professors would probably make the same nuanced statement that I would make: If you accept the assumption that people want to maximize their payment then according to this model they act irrationally.  

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### Answer by username_30 on 2018-03-15. Score: 2

The "single monopoly profit theory" is often viewed as quite counter-intuitive:

> Leverage of market power cannot be used to profitably foreclose a rival.

Suppose there are two products, A and B. A is monopolised and produced only by firm 1; B is supplied competitively by both firm 1 and firm 2. Common sense presents to following concern: firm 1 might try to use its market power in A to become a monopolist in B and foreclose competition from firm 2. One way to do this would be to bundle A and B1 together. Everyone who buys A would also be forced to buy B1, even if B2 were the better product. This would make it difficult or impossible for 2 to achieve any sales.

This logic is flawed, as the Chicago school pointed out. Suppose consumers will pay $v$ for A, $v$ for B1, or $v+\Delta$ for B2 (so $\Delta$ is firm 2's quality advantage). Suppose that A and B1 are bundled and that consumers buy the bundle. In a desparate attempt to win business, 2 will cut the price of B2 to zero (this is the usual Bertrand logic). Thus, consumers will buy the bundle if
$$2v-p\_1\geq v+\Delta\implies p\_1\leq v-\Delta.$$

Thus, the best 1 can do through bundling is to earn $v-\Delta$ from each sale of A and B1. But it could do better simply by selling A at a price of $v$ and giving $B\_1$ away for free. Thus, the claim that bundling/leverage of market power is a profitable way to foreclose competition turns out to be logically flawed.

---

Addendum: subsequent work has shown that leverage of market power is possible in various situations. But the conditions needed for it to work are more intricate than suggested by common intuition.

> **Comments:**
> **username_30**: @user253751 Yes, good observation! If A is "essential" (as we usually say in the literature) then the argument changes slightly, but the end result is the same.   Under bundling, if A is essential, then the only relevant options are to buy the bundle or to buy nothing at all and get a utility of zero. So that most that can be charged for the bundle is $2v$. But firm 1 could guarantee itself a profit of $2v$ without bundling by charging $2v$ for A and $0$ for B1. So, again, bundling doesn't help the firm.  

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### Answer by username_42 on 2021-02-12. Score: 2

**It is impossible to beat financial markets.** There is clearly a huge variation in views on how literally one can take this assertion and on how informationally efficient financial markets are, but almost all economists would agree that reading books on "the spectacular new trading system Wallstreet does not want you to know" and getting investment tips from financial analysts on TV or YouTube is a colossal waste of time.


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### Answer by username_43 on 2018-07-18. Score: 2

> ''Diamond Paradox'' by [Diamond (1971)](http://cemi.ehess.fr/docannexe/file/2360/diamond.pdf)

This is a "less-known paradox," usually put as a counter to famous Bertrand paradox. It is a starting point in the literature on informational frictions in consumer markets, and the scientists in the field agree on its significance.

Its idea is diametrically opposite to that of Bertrand. Consider the following simple example. There are $2$ firms which produce homogeneous goods at zero marginal cost and compete in prices, $p$. This simultaneously set prices. Also there is a single consumer who supplies a demand given by $1-p$. Importantly, the consumer does not observe prices set by firms and, therefore, needs to search for them sequentially, where search is costly. Suppose that cost of visiting a firm is given by $0 < c \leq \frac{1}{2}$. Then, the unique equilibrium of the market is that both firms charge monopoly price
$$p^M= \frac{1}{2}.$$

This is a diametrically opposite result to that of Bertrand.

The reasoning behind the result is as follows. Suppose both firms charge $p=0$. Then, the consumer randomly visits one of the firms, say firm $i$, and buys. However, firm $i$ could have charged $c$ and made positive profits as the consumer would have bought goods anyway because she would have suffered cost $c$ had she left firm $i$ in order to buy from the rival firm. By the same argument, one can see that $p=c$ cannot be an equilibrium as now firm $i$ can charge $c+c$ and improve its profit. Continuing this way, it is easy to arrive to an equilibrium where both firms charge $p^M$. A firm does not want to charge $p^M+c$ simply because its profit is maximized at $p^M$.

> Formal Analysis of the Example

**Timing:** First, the firms simultaneously set prices. Second, the consumer without knowing prices engage into sequential search. The first search is free and the consumer visit each firm with equal probability. The consumer can come back to the previously searched firm for free. The consumer has to observe a price of a firm to buy goods from that firm.

**Beliefs:** In equilibrium, the consumer has correct belief about strategies of firms. If, upon visiting a firm, she observes a price different from an equilibrium one, the consumers assumes that the rival firm has deviated to the same price too. Thus, the consumer has symmetric (out-of-equilibrium beliefs). Note: the results of the game does not change if the consumers has passive beliefs.

**Strategies:** Strategies of the firms are prices. As mixing is allowed, let $F(p)$ represent the probability that a firm charges a price no greater than $p$. Strategy of the consumer is whether to search for the second price, upon observing the first one. This strategy is given by a reservation price $r$, such that upon observing a price lower than $r$ she buys outright, upon observing a price greater than $r$ she searches further, and upon observing a price equal to $r$ she is indifferent between buying immediately and searching further.

**Equilibrium Notion:** Concept of Perfect Bayesian Equilibrium (PBE) is employed. A PBE is characterized by price distribution $F(p)$ for each firm and the consumer's reservation price strategy given by $r$ such that $(i)$ each firms chooses $F(p)$ that maximizes its profit, given the equilibrium strategy of the other firm and the consumer's optimal search strategy, and (ii) the consumer searches according to the reservation price rule $r$, given correct beliefs concerning equilibrium strategies of firms.

**Theorem:** For any $c>0$, there exists a PBE characterized by triple $(p^M, p^M, r)$, where $p^M$'s are charged with probability $1$ and
$$r=1.$$

**Proof:** First, I prove that $r=1$, or that the consumer buys outright when she observes any price lower than $1$. Clearly, if she observes a price greater than $1$ she does not buy from that firm as this yields a negative payoff to the consumer. Now, suppose she observes price $p'

Next, I prove that both firms charge $p^M$. Clearly, firms never charge above $1$ as they will never sell. Then, the expected profit of a firm is $\frac{1}{2}(1-p)p$ because the consumer visits a firm half of the time. It is easy to see that the profit is maximized at $p^M$. **QED.**

> **Comments:**
> **username_43**: @denesp I'm afraid there is no textbook that I'm aware of where the paradox is discussed.  You can find short analysis of its some forms in papers on search.  

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### Answer by username_44 on 2018-03-18. Score: 2

Nice question! I would like to add a few elusive ones that I think are important.

[Natural selection](https://en.wikipedia.org/wiki/Natural_selection) does not require intelligence. It is more of a biology theory, but its economic implications are vast. [Evolution of cooperation](https://en.wikipedia.org/wiki/The_Evolution_of_Cooperation) is very useful but often ignored by economists and politicians as it goes against some common sense rules.

The entire theory of probability is counter-intuitive and has plenty of traps in economics for those who use only common sense. One example is a [Monty Hall paradox](https://en.wikipedia.org/wiki/Monty_Hall_problem): once you made your decision with limited information, you will gain by changing your decision when you get more information. A common fallacy of "throwing good money after bad" stems from ignoring this principle. Literally everyone has been guilty of it.

> **Comments:**
> **username_41**: The biological examples are nice, but explaining them would greatly improve this answer. "throwing good money after bad" has nothing to do with Monty Hall. It is a coping mechanism for the cognitive dissonance arising from having made a bad decision.  

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### Answer by username_45 on 2021-09-05. Score: 1

**Price control hurts consumers.**

So called price gouging is a specific example. Most states even have price gouging laws, which limit how fast price for some consumer goods can increase. And it is very common to hear complains from both laymen and not-so-laymen about price surge and "speculation".

Price is an equilibrium outcome, which equalizes demand and supply. In other words, market price is a price, at which quantity supplied is exactly equal to quantity demanded. So what happens when the price is restricted below its market level? Shortage. At such price demand outstrips supply, so we see empty shelves.

There are two main negative consequences of anti-price gouging laws. First, consumer surplus decreases, since the product is consumed not by consumers, who value it the most, but by consumers, who happen to buy it when it is available.

Second, and the most important one, is that supply will not adjust to accommodate rising demand. Without price control, high prices imply increased revenue of producers, incentivizing them to ramp up production fast. So after a while supply increases and equilibrium price falls. Under price control no increase in supply is possible, since it is not profitable for producers. So the shortages will last up to the point when demand shock passes. If demand shock is permanent, then shortage will be permanent too.

> **Comments:**
> **username_45**: @user253751 Your argument works only statically if you fix supply at a constant level. No matter how large the preference for random allocation your social welfare function could imply, an increased supply from extra incentives to producers would always outweigh it after some time. You can consume only what is produced.  

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### Answer by username_46 on 2018-03-14. Score: 0

The best answer to this question has to be pricing. It is agreed in economics that pricing reflects the supply and demand and it depends on these on a free market. Still, you'd often hear people how some product is too expensive because it is just some *raw material* plus some *working hours*.

Even worse, you sometimes see business owners billing their service or products by some amount of material and some hours of labour. For e.g. a carpenter who sells some closet for 1.2 cubic meter of wood at 800\$/cubic meter + 30 hours of work at 90\$ per hour, giving a grand total of nobody cares. Because if someone comes in and says I want that closet for 1 million euros and you're willing to give it for that money, that's PRECISELY what it's worth. Exactly in the same way as if someone comes in and wants to pay you 100 euros for the closet, you can't claim it's worth at least the material+labour, because nobody is willing to pay that money, so it's not worth that much, but PRECISELY 100 euros.

In a nutshell, it is a consensus in Economics that prices are driven by supply and demand on free market, but for some reason people very widely believe that it's common sense that prices are driven by production costs.

> **Comments:**
> **username_2**: uhm have you ever sat in a micro lecture? Because most of that is arguing that in equilibrium on a competitive market prices will be equal to costs. Because if it is above cost you will have entry and below cost firms will close. Which means you end up with prices at cost. And this makes markets efficient. If everyone who has higher utility from the product than it costs gets it, aka when the price equals cost, then you get a pareto optimal outcome. Effectively when considering a product, you consider if the value it provides is higher than the cost it causes (the price).  
> **username_47**: Actually, the price is equal to the marginal cost of production in any efficent market.  
> **username_46**: @FelixB. and repmat Both of you made my point. People noticed that there is somehow a correlation between production costs and prices, and immediately assume that prices must be driven by production costs, which is something economists agree it is not true. It's as if you're watching a carriage with a horse and deduce that the carriage must push the horse further, since they're both going at the same speed.  
> **username_2**: @Andrei but you complain about "you'd often hear people how some product is too expensive because it is just some raw material plus some working hours" and if you agree, that in a competitive market the price should be marginal cost, then you also have to agree that if it is not at marginal costs, there is a market failure and the people are right to complain about the wrong prices. So it is a fine thumb rule to consider the costs.  
> **username_33**: If something has a low cost to produce and is selling for a high price, probably somebody else will notice and start making their own and sell it for a lower price (either to undercut the other guy or because of the increased supply to demand ratio). Production costs determine how low the price can go in such a situation. Furthermore, if somebody spends \$1 to make something and tries to sell it for \$100, he may have a hard time finding a buyer if the public is aware of the low production cost. This generally lowers the price.  
> **username_46**: You are all literally making my point. You just don't get how the market works and you're also not reading the answer. Any price is simply an agreement between the buyer and the seller. None of you answered why wouldn't a transaction happen when the production costs and the price are far off, if the buyer and the seller agree. All of you suggest that that can't happen when it is happening everyday. See cpu prices, airplane first class seats, fashion, etc... I am actually glad that I have the lowest score on this answer, as it stands as proof that it's something easy, yet nobody gets it  
> **username_2**: Lets's split this into two cases: 1. You make a descriptive statement: "Prices in a free market are determined by supply and demand". This is true, but no one disputes that, it is also common sense. What people dispute whether prices _should_ be determined by supply and demand. So Case 2: You make a normative statement: "Prices should only be determined by supply and demand". And that would be wrong, because for pareto-efficiency you want prices to be at marginal costs. If markets work, then those coincide. If markets fail then prices _should_ still be at marginal costs.  
> **username_46**: @FelixB. Life is not a game and not even the cruelest dictators can tell the market how to behave. The expressions "prices should be" or "you want prices to" do not even make sense in real life. What is the point to discuss what you want prices to be when that is a provable impossibility?  
> **username_2**: Because you need prices to be at marginal costs for your economy to be even pareto efficient (which is such a weak requirement that everyone would agree is the minimum that we should strive for). And yes you can set price ceilings as a state. And in case of monopolies that sometimes makes sense.  
> **username_48**: @Andrei The quantity supplied is dependent on the price customers are willing to pay.  If it costs me 200 dollars to make a carriage and customers are only willing to pay 100 dollars for a carriage, then I simply will not make the carriage.  It's only if the customer is willing to pay more than 200 dollars that I will be willing to make the carriage.  So my costs of producing the good are highly relevant to whether the good gets produced, and thus the price the good is sold at.  

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