Ultimately it depends on how much of the benefit of the given investment the firm gets. If we have a market where firms get all the benefit from their investment (it is both specific and they can extract the whole surplus that is created), then perfect competition would work fine. However, when we change those conditions there can be all sorts of complications (e.g. if your investment can be used by all other firms, then in perfect competition you only get an infinitesimal proportion of the gain, and so will hard out under-invest).

However, I’m pretty comfortable looking at the question of innovation and equilibrium adjustment separately for now, although I am sure there is plenty of interesting overlap.

As long as perfect competition as a comparison is fine, as long as its not used as a reason to interfere in otherwise free markets.

If we are in a situation where the benefit to the consumer and the producer outweighs the transaction cost, but the transaction cost is greater than the benefit to the consumer or producer alone, then without some sort of co-ordination we will remain in a sub-optimal situation. This is because the consumer or producer won’t have the incentive to pay the transaction cost to get the benefit even though it is socially optimal.

In this case if one could compensate the other, or if they could share the transaction cost, then we could head towards a socially optimal equilibrium. But without that we end up in a pareto inefficient equilibrium.

The list price of the pie does not include the transaction costs, but if you were to draw a diagram as above, you would need to include these in the ‘price’ and therefore would come to the equilibrium given the information available.

Get their phone number and call ahead to reserve the pie!

(Also works if you want to get the last blue budgie in the shop.)

I agree that if I signaled my interest instead of buying a substitute we could head towards equilibrium. However, it is costly for me to apply that signal, I really don’t want to go up and ask for that pie. As a result, the asymmetric information remains, and the transition to equilibrium just doesn’t happen.

The reason I am quite sure that we are out of our perfectly competitive global equilibrium is that I’ve seen other people looking for the chicken pie, and if I don’t get down there early enough (and sometimes even if i’m down there at 10.30 when the pie is still cold) the damn chicken pie is gone. I think that there is a lot more underlying demand for the chicken pies, but people like me just keep on grunting and buying the curry ones instead 😉

On a side note, I like pies because they are cheap, if I could get an equivalent lunch in some other way for only $3.90 I would be interested. If there was a chip and fish store nearby that might do the trick 😉