Assumptions and Reality: is there a connection?


The economies with observed congruence of supply and demand tend to be rich and economies with shortages of some goods and overproduction os others tend to be poor. Is there any connection?

This tendency to seek “efficiency”, i.e. to sell what others buy without generating waste, is formally explained by the First Welfare Theorem (FWT).
The FWT supports Adam Smith’s assertion that individuals who act selfishly end up behaving in a way that is desirable from a social standpoint. this is what makes congruence between what individuals want to sell and what others want to buy even though there is no explicit social coordination.

This theorem underlies six main assumptions that are very hard to hold in real life but can explain the connection between “efficiency” and the causes of a rich or poor economy.

However, when analyzing the conditions of different economies we can observe that there are realities that adhere more to these assumptions. These realities derive from the historical background, the type of government, the rules and public policies aimed at “efficiency”.

First, the easiest assumption to compare is that of “well-defined property rights” because it can be observed in the legal framework of countries with rich economies. One of the characteristics of these legal frameworks is the protection they provide to private property, their terms are more transparent and give greater certainty due to better enforcement of laws. On the other hand, in poor economies there are enforcement problems or very complicated and non-transparent legal structures that do not guarantee the protection of property rights; even some of these economies are governed by authoritarian regimes where the existence of these rights is null and void.

Second, in rich economies, there is regulation to eliminate or lessen the distorting effects of negative externalities or to take advantage of positive externalities. In poor economies, however, little or no regulation of these market failures exists. This can be compared to the assumption of the non-existence of externalities, but since is impossible to eliminate externalities at least there are efforts to reduce their effects.

Third, in rich economies, inequality among participants is lower compared to the inequality faced by individuals in poor economies. The inequality that characterizes the poorest economies does not allow all their individuals to participate in all markets (i.e. education or employment) because the markets that develop in these economies are far from complete as the assumption states.

Fourth, in rich economies, there is regulation to protect free competition and thus avoid monopolistic practices. In contrast, poor economies have very little experience in regulating monopolies and their markets are characterized by the existence of large and powerful monopolies, which contradicts the assumption that the agents are price takers.

In reality, the most difficult assumption to replicate is that in which all agents face the same prices, because in countries there are States that need resources to carry out the control of the country and the application of public policies for which it is necessary to collect taxes. Taxes generate distortions whereby not all agents face the same prices.

In conclusion, it could be possible that the more developed economies have oriented their policies and laws to generate conditions that adhere to the assumptions of the model and that this is the reason why they present greater congruence between their supply and demand for goods. In contrast, the less developed economies are in opposite positions to the assumptions, which could explain why they have less congruence and are farther away from “efficiency” in their markets.