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8). In Other Words, Despite Claims That Economics Is A Positivist Subject, It ...

8). In other words, despite claims that economics is a positivist subject, it is committed to a specific normative theory of good (Hausman and McPherson, 1996). That theory says that what is socially desirable maximises the gains from trade. What does this mean?
Let us return to the excess demand example mentioned above. Imagine that at the initial market price, purchasers of houses are rationed not everyone who wants to buy a house at the existing price can get one. It is simple to demonstrate that at this price, the increase in price needed to induce producers to build just one more house is strictly less than what potential purchasers would be willing to pay a producer in order to build that house (Landsburg, 2002; ch.8). Given that this condition is satisfied, it is always possible for a mutually beneficial trade to occur between a potential buyer and a potential seller.
To illustrate this, imagine that a producer of houses (a builder, say) needs the price of houses to rise from £100,000 to £118,000 in order to find it profitable to build 11 houses as opposed to 10. If there is a situation of excess demand in the market whenever the price of a house is £100,000 then it is always possible to show that the maximum price someone would be willing to pay in order to induce the producer to build the additional house is strictly greater than £118,000. If that price is, for example, £150,000, then the two parties can trade to their mutual advantage. Imagine that the potential buyer offers the producer a price of £125,000 in order to build the house. This is a price the producer will happily accept. He or she would have built the house for £118,000 but instead gets £125,000 the producer is better-off by £7000. Economists say that producer surplus rises by £7000 (Landsburg, 2002; ch.8). Similarly, the buyer gets the house for £125,000 but was willing to pay £150,000 for it. The buyer is better-off by £25,000. Economists say that consumer surplus rises by £25,000 (Landsburg, 2002; ch.8). An important insight from economics, as seen in this example, is that mutually advantageous trade is possible. Trade is not necessarily a zero-sum game.
How does this relate to the idea that the equilibrium price is the socially desirable one? It does so in the following way. As the excess demand in the market is gradually eliminated through upward movement in prices, the scope for mutually advantageous trade between buyers and sellers shrinks. Remarkably, when the excess demand for houses vanishes and the market is in equilibrium, no more mutually advantageous trades are possible. The price that would induce a producer to build an additional house is equal to the maximum price someone would be willing to pay for it neither consumer surplus nor producer surplus can rise if this trade takes place.


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