Market Ethics with Trade in an Edgeworth Box

The fundamental assumptions in all neoclassical economic models are that individuals are self–interested, and rational.  They will use all information available to them (in many instances that information will be perfect) and take actions to maximize profit in production and utility in consumption.   Homo economicus is the term commonly used to describe individuals with these behavioral characteristics in economic models.    To many people the homo economicus assumption is often viewed with suspicion or derision.   The popular perception is that economic man is excessively greedy and will do anything in his power to improve his lot.   He has no “other-regarding” or altruistic preferences.   In short, he is not a very pleasant person.

Although economics praises self-interest, even greed, as beneficial to the workings of the economy and society, many other social observers consider greed to be an immoral trait that would best be supplanted by altruistic behaviors.  Because homo economicus is a cornerstone of the entire neoclassical paradigm, students that are new to economics, sometimes quickly infer that economic theory does not contain a moral compass.   This paper confronts these perceptions by highlighting that in order for markets to function effectively it is critical that individuals adhere to several ethical constraints.  These ethical principles are embedded in the assumptions of economic models and are often presented in the early economics literature, however, they are downplayed so much in introductory textbooks today that it is likely that most students leave their first courses with an unsatisfactory appreciation of the importance of ethics in economics.  In a review of the top introductory microeconomics textbooks, it was found that none of the texts discuss what Coleman (1985) described as pre-market failures; namely failures in the ethical principles that underpin a functioning market and that are needed in order for perfectly competitive markets to even be possible.

This paper uses an Edgeworth box diagram to first highlight what are the foundational ethical principles of a pure exchange market; second, why adherence to this system of ethics enhances the effectiveness of the market; third, the limits of the homo economicus assumption and why market effectiveness requires restraints on self interested behavior; and fourth, the methods that have been employed, both private and public, to encourage ethical behavior and how they assist in maintaining market effectiveness.