New goods, market formations, and pitfalls of system design

The standard practice in economic theory is to assume that all the relevant variables (e.g., the space of all the goods of potential economic value) and all the relevant constraints are known to the policymaker or to the designer of an economic system. This often unstated assumption (or the belief implicitly embodied in it) inadvertently creates an illusion about our ability to design an economic system and control process of resource allocation. In this paper, a series of examples is developed to illustrate that this modeling approach has the danger of misdirecting our attention when evaluating alternative forms of an economic system. Some implications for reforms in the former socialist economies are also drawn. J. Japan. Int. Econ., December 1995, 9(4), pp. 376-402. Department of Economics, Northwestern University, Evanston, Illinois 60208; NBER; and TCER.