Elemental Parts of Free Market Exchange

Introduction:

In common economic theory, we describe the functional elements of free market economies. We consider these elements desirable because they are positive-sum. We fear command economies because we believe that they are zero-sum or negative-sum. These concerns are justified, but our beliefs about where we find positive-sum vs. zero-sum economies are not totally accurate.

Last Updated: January 2010

 

 

 
Positive Sum
In the classic example of positive sum exchanges, a farmer grows food and a metal smith creates farming tools.  The farmer trades food for tools with the smith.  Both are wealthier from the exchange.  The farmer will have tools that help him grow food more efficiently; the metal smith will have food that will sustain him to create more tools.  Positive-sum exchange is also called win-win, and mutually beneficial exchange.  We like to believe that our economy works because it is made up of mutually beneficial, i.e. positive-sum, exchanges. 
Zero Sum zero sum
Zero sum exchanges occur when one party’s gain is exactly equal to the other party’s loss.  These are also called win-lose situations.  Examples include theft, charity, and pyramid schemes. In each of these examples one person gains, but only does so because another person suffers loss.  Complaints against socialism are based in the idea that socialism is zero-sum, while the claim is made that capitalism is positive-sum.  Below we shall discuss how reality is not that simple. 

Negative Sum:

Negative sum exchanges occur when wealth is destroyed in the process of the interaction. Examples include vandalism and war.  Negative sum exchanges destroy wealth, or reduce the total wealth available.  Many negative-sum situations are called lose-lose, but it is possible for one party to profit from a negative sum situation.

negative sum

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Putting it all together:
In fact, no human actions or exchanges are purely positive-sum or zero-sum.  All work-based exchanges have a positive sum part, a zero-sum part, and a negative-sum part. There are always overlooked costs and consequences.  Humanity gains the most when negative-sum and zero-sum exchanges are kept small, while positive-sum exchanges are maximized. mixed

We can recognize that positive-sum exchanges tend to have different characteristics than zero-sum and negative-sum exchanges.  We can examine economic transactions for the characteristics of each type. From this we can estimate the efficiency of the economy, or determine if our economy is operating near peak efficiency. 
In positive-sum exchanges involved parties tend to receive comparable amounts of work and money or goods. Productive work has been done by all the parties involved, and it will typically be easy to see how each party gained from the work of the other. 
 If one party is taking significantly more money or doing significantly less work for the money then the exchange most likely is comprised of a large zero-sum element.  Large profits by small groups or individuals typically indicate large zero-sum factors in the group’s transactions.  The economy is acting inefficiently. 
If large profits are being made while resources are being reduced, e.g. factories closing, workers being laid off, environments being polluted or destroyed, then a strong negative-sum element is part of the exchange. The economy is not operating efficiently or sustainably.  Both excessive profits and excessive destruction are indicators of economies that are not operating effectively as positive-sum economies, because they are being burdened by large negative-sum and zero-sum costs.

Free markets should contain tightly linked feedback. But does our economy really contain this feedback? Let your community organization examine situations for yourselves.

 
Real Life Exchanges
Let’s examine some transactions that appear to represent one type of economy to see how the other types are included.
Charity:  Charity, of which welfare is an example, may have positive sum consequences.  Charity may reduce a person’s sense of hopelessness and alienation, thus decreasing the likelihood that he will steal or commit other crimes.  This is a positive-sum outcome of an apparent zero-sum interaction.  The reduction in alienation and stress may help a person reintegrate himself into the working community, thus accelerating his positive interactions with the community.  In this manner, charity, which appears zero-sum on the surface, can have positive-sum consequences in the long-term. 
Hidden-Profiteering:  A well known story exists of programmers who worked for banks.  They realized that banks have thousands of transactions each day in which a partial penny payment must be rounded to the nearest penny.  They wrote the bank software such that each time a transaction was rounded, the penny was deposited into their account.  Thousands of pennies each day added up to a rather sizable unearned, i.e. zero-sum, income.  The programmers had done real work for the bank, so the initial exchange was positive-sum.  But they added to that exchange a zero-sum element. 
In the same manner, corporate hierarchies have both a positive-sum part and a zero-sum part.  Executive salaries frequently have more to do with the executive being at the top of the pyramid than the executive providing significantly more real work to the company.  The status element of his compensation is zero-sum; the work element of his compensation is positive-sum.  When an executive earns multimillion dollar salaries, or salaries in excess of one hundred times his employees’ compensation, it is safe to conclude that the zero-sum part of his salary is larger than the positive sum part of his salary. 
Corporate Shuffling:  In the last 40 years, down-sizing and leveraged takeovers have been so common as to seemingly cease to be newsworthy.  The people who “manage” the corporate shuffling are doing “work.”  But closing factories and laying off workers constitutes a reduction of real wealth and potential.  The actions from which the managers are making their profits are actually negative-sum. Many people claim that these managers are doing work, and that work is positive-sum.  But most of their profits from their work result from a negative-sum, a reduction in wealth overall. 
Pollution:  Most modern work has consequences far beyond the property on which it is performed.  Air and water pollution are the prime examples.  Farms and factories pollute the streams which either kill fish downstream or make the water undrinkable. The farms and factories are doing real work, producing real goods, so their actions are, in part, positive-sum.  However, their downstream consequences, which typically impact somebody else, are negative.

Summation:

We describe our economy as being a free market positive-sum economy. However, if we look, we will see strong indicators of major zero-sum and negative-sum elements all through out our economy. These include climate change, ocean dead zones, large deficits, the crash of 2008, executive salaries, etc. Our economy is not running according to the efficient principles that we believe in. We may argue as to how large exactly the zero-sum and negative-sum elements are in the various parts of our economy, or why they are so large, but those parts are clearly present.

 
 

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