What is it worth to take someone else’s speeding points? The Huhne-Pryce case has brought this into sharp focus. Setting aside the moral issues, the question raises interesting topics in economics.
It turns out that there is a market in these points. The Daily Telegraph discovered that prisoners are willing to take points. By the time they get out, the points will often have expired. For around £200, someone will take your three points. But mingling with a group of England supporters after the Wales debacle on Saturday, their tongues loosened by alcohol, I discovered that one respectable woman claimed to have done it for £500.
How does this market work? How is the price actually decided? Like many questions in science, the ones which seem easy to ask are often the hardest to answer. Vernon Smith, economics Nobel Prize winner in 2002 noted as much in his acceptance speech when he stated ‘we do not understand why markets work as they do’.
The basic textbooks give a pat answer to how the price is set. It is a simple matter of supply and demand. Price is where supply equals demand. But the market for points is more complicated. For example, there is a lack of transparency about other transactions. It is not prudent to enquire too extensively about what the going rate might be. Further, there is no institutional setting which regulates the conduct of the market to balance supply and demand at any point in time, so transactions can take place at what the textbook would regard as non-equilibrium prices.
Leading economists wrestled with these problems at the turn of the 19th century, when economic theory was first formalised. Alfred Marshall founded the economics department at Cambridge around 1900. His contemporary, Edgeworth, believed that there was inherent uncertainty about the outcome of the interplay between supply and demand. In any given situation, there would be a range of potential outcomes for price. He developed a useful tool, the Edgeworth box, for thinking about it. Marshall simply assumed the problem away, and Marshallian diagrams of supply and demand, each with a uniquely determined price, have dominated economics textbooks ever since.
Interest in these problems has revived in the 21st century. In many financial markets, for example, prices are set by a formal set of rules known as a continuous double auction. It seems to be the case, for reasons we do not yet fully understand, that this process itself generates some of the key features of changes in financial asset prices such as ‘fat tails’ – the fact that very large changes, whilst rare, are much more frequent than financial regulators believed before the crash.
Increasingly, the world is full of complex products and services. Naive supply and demand analysis can only take us so far in understanding how their prices are set. Institutional structures, price setting mechanisms, information flows, all these need adding to the mix. The market for speeding points illustrates key aspects of our modern world.
Paul Ormerod
As published in City Am on Wednesday 27th March
