After the simulation
LECTURE 4 · PART 3
Arbitrage, Islamic norms and cooperation, and the question of efficiency
A
B
C
D
E
F
P
Q
R
S
T
U
What drove the changes?
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Students bid up the cheapest contracts.
Owners undercut the dearest contracts.
Their actions narrowed rent differences.
Range of contract rents
Start
150–500
End
310–340
100
200
300
400
500
F paid 500, then won P’s room at 210 after a price war with B. What made that move possible?
Lecture 4 · Building a Model Together
A quick test of any proposed rules
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Suppose identical rooms have different rents. Who could gain? What permits, or prevents, their move?
Question | What to inspect in the model |
Can people discover better terms? | Information and communication |
Can they act on them? | Access to rooms and permission to make offers |
Can agreements be revised? | Cancellation and finality |
Is changing worthwhile? | Costs and minimum improvements |
Will people pursue the gain? | Behaviour and motives |
Lecture 4 · Building a Model Together
What happens after the first move?
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Follow the consequences, as in round 1 of our simulation:
Who is displaced?
B, when F wins P’s room.
Which room becomes available?
T’s, but its owner will not go below his minimum of 450.
Who can respond next?
Q, on the cheapest contract, undercuts S to win E.
Which of our rules would you remove if you wanted rent differences to persist?
Lecture 4 · Building a Model Together
What does the test tell us?
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Blocked opportunities
help explain persistent differences.
Open opportunities
suggest pressure toward convergence.
The complete process
determines whether convergence occurs.
Our run converged. The OOPS moment showed that rules can also produce moves no person would make.
Lecture 4 · Building a Model Together
Apply the same questions to an actual market
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For a market you know:
Can people discover, obtain and act on better terms?
Can that process continue across the market?
You discover that a friend pays less for an identical room. What can you actually do?
Lecture 4 · Building a Model Together
Stopping is not enough
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Posted prices
5 housed
Rents 150, 200, 400, 450 and 500
Stopped because agreements were final.
Price wars
3 housed
Rents 310, 330 and 340
Stopped because no worthwhile move remained.
Why the market stops matters.
Lecture 4 · Building a Model Together
What did the market need?
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To reach the textbook outcome, our market needed:
Agreements that could be overturned
Students outbidding a sitting tenant (F displaced B)
Owners luring another owner’s tenant (Q took E from S)
Rent as the only motive: no loyalty, no fairness
B and C lost rooms they had already secured.
Lecture 4 · Building a Model Together
What do Islamic norms say?
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Fulfil your contracts. (Qur’an 5:1)
The parties themselves may reconsider within an agreed option period (khiyar).
No one may bid over his brother’s bid, sell over his brother’s sale, or propose over his brother’s proposal. (Bukhari, Muslim)
Open auctions before any agreement are permitted.
Our two price wars, outbidding a sitting tenant and luring another’s tenant, are exactly what is forbidden.
Lecture 4 · Building a Model Together
Why these norms?
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Agreements are a trust
A deal made in good faith should not be snatched away: “no harm, and no returning harm”.
Relationships matter
Jurists explain the prohibition by the resentment such rivalry breeds. Markets sit inside a moral community.
Competition is not rejected
Open bidding before agreement is allowed. What is ruled out is undoing another person’s agreement.
Lecture 4 · Building a Model Together
Another way: cooperate
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Match each student with an owner she can afford, at a rent that meets the owner’s need.
Student (maximum)
Owner (minimum)
Agreed rent
A
100
P
50
75
B
200
Q
150
175
C
300
R
250
275
D
400
S
350
375
E
500
T
450
475
F
600
U
550
575
All twelve
Six students housed, each within budget. Six owners let, each at or above his minimum.
Six different rents.
One price can house at most three. The law of one price is the barrier to housing everyone.
Lecture 4 · Building a Model Together
When more students arrive: share
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G
A new student, G, arrives with a budget of 450. Every room is taken.
Under competition
G offers P more than A can pay. A, the poorest student, loses her room.
Under cooperation
G joins A in P’s room. P still receives 75: G pays 50 and A pays 25.
Newcomers join by sharing: each gives up some comfort, rents fall, and no one is displaced.
Lecture 4 · Building a Model Together
The brotherhood of Madinah
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The Prophet (peace be upon him) paired each emigrant from Makkah with a host among the Ansar of Madinah, who shared their homes and property.
“They give preference to others over themselves, even though they are in need.”
Qur’an 59:9
“Cooperate in righteousness and piety.”
Qur’an 5:2
Offered half of Sa‘d ibn al-Rabi‘’s wealth, Abd al-Rahman ibn Awf asked instead: “Show me the market.” (Bukhari)
Lecture 4 · Building a Model Together
Two societies
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| Built on competition | Built on cooperation |
Who is housed? | Three: those who can pay most | All six; newcomers by sharing |
Who lets a room? | Three owners; three rooms empty | All six owners |
How are rents set? | One rent, from price wars | Rents matched to means and needs |
What is rewarded? | Pressing every advantage | Restraint and helping others |
What does it make of us? | Rivals | Brothers and sisters |
Same people, same rooms. Different norms, different outcomes.
For later: which outcome is better (welfare)? Does self-interest serve society best (invisible hand)?
Lecture 4 · Building a Model Together
Why favour the competitive outcome?
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Economists describe the competitive allocation as efficient:
it maximises total gains from trade, measured using buyers’ reservation prices and sellers’ minimums.
Next lecture: what does that calculation count, and what does it leave out?
Lecture 4 · Building a Model Together
If competition is blocked, remove the barriers?
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Barriers to arbitrage: can prevent the competitive allocation.
The textbook response: remove barriers and improve efficiency.
But for the people in our market: what would that mean?
Lecture 4 · Building a Model Together
Next lecture: efficient for whom?
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5
housed under posted prices
3
housed under competition
6
housed by cooperation, with all six rooms let
Why does the textbook call the competitive allocation efficient?
Lecture 4 · Building a Model Together