But there are limits and issues to be considered. In my series of posts on calculation vs. incentive problems, I highlight the importance of incomplete property rights regimes for considerations of when state action may be more efficient than market action. Contrary to the imputations of some commenters, I'm thinking of instances where the state can augment market investment and allocation, rather than substitute for it. I've also alluded to times where we think a prioritarian ethic might take precedence over a strict utilitarian ethic. Markets cannot satisfy prioritarian goals, because the price mechanism doesn't distinguish between the utilities of different persons.
I have been too busy to respond to detail to his most recent posts, but I wanted to highlight one thought I had in relation to this point that Mattheus makes:
"Certain types of allocation? The price system is the only tool EVER designed to allocate resources to any modicum of efficiency. It is a procedure that has unbelievably obvious success in meeting needs. If you are going to make a product or service to meet the needs of some people, and you do not use the price mechanism - what other recourse do you have? How can you possibly do it efficiently?"
As a side note, I would disagree with the Mattheus that the price mechanism is "designed", but that's another matter entirely. This point reminds me of a long-standing concern about markets that I've had, which I've never had the time to think through carefully. My question is simply: what about needs and demands that are correlated with a person's ability to pay?
We use examples about the relative demand for apples and oranges, and the way that the price mechanism coordinates the needs and demands of millions of people for apples and oranges, but we leave the question of income curiously vague. We act as if one person who subjectively values an apple more than another person will offer to pay more for that apple, but this of course isn't necessarily true at all. The prices we offer for goods is not only a function of our subjective valuation of that good. It's also a function of the income we have available to spend on that good. Writ large, this of course is an insight straight out of Keynes. But it also has important microeconomic consequences.
My family makes a fairly healthy income, and I feel no uncertainty at all that our standard of living will only improve over time. What I will be willing to pay for things is going to be informed by this. It's entirely plausible that I would be willing to pay twice as much for the same orange as a lower-income family standing next to me in the grocery store, despite the fact that I actually prefer apples to oranges (I'm getting a variety of produce), and in fact that other family values oranges more highly than I do. I haven't been able to think through the implications, but this would seem to throw a monkey-wrench into the efficiency of the price mechanism. How can the market communicate information about subjective valuation if those subjective valuations are mediated through a person's ability to pay? Prices are at the very least communicating information about both subjective valuation and ability to pay. Maximizing total subjective valuation is what we always like so much about the market - but what are the implications if we're actually maximizing a combination of subjective valuation and ability to pay?
From a general equilibrium perspective, of course, ability of pay is closely related to a worker's marginal productivity (how much they earn in the labor market). In that sense, it's not entirely disconcerting that the price mechanism in the product market is going to reach a general equilibrium with the price mechanism in the labor market (which is ultimately a major determinant of ability to pay). But it's not that simple. Ability to pay is also largely determined by the circumstances of birth, genetics, and the willingness of parents to make investments in their children.
Regardless, the importance of the ability to pay in mediating the willingness to pay is something that I don't think has been sufficiently considered by economists. The ultimate effect is that people who have a higher ability to pay will be treated by the price mechanism as if they have a higher subjective valuation of goods and services by virtue of their higher willingness to pay.
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It makes me rather happy to see that you value (subjectievly) my comments and rebuttals on earlier posts so much to warrant full new threads aimed at addressing our differences.
ReplyDeleteAnyway, to the post itself:
"My question is simply: what about needs and demands that are correlated with a person's ability to pay?"
I deliberately used apples and oranges because they are plentiful and within the price range of the majority. No one is really inhibited from buying 1 apple as opposed to 1 orange because of differences in price. That said, would my explanation of the orange/apple market process be any different if, instead of produce, I talked about tanks and helicopters?
Certainly there are some people that would value the incremental gain from one tank more than they might a helicopter, and vice versa. There would exist a market for these goods that is determined by the market participants - even it is controlled by a monopsony like the US government. The individual person's inability to pay for these items in no way affects the buying price or quantity because, well, they aren't buying them; just like the market for parachutes isn't affected by my absence from the parachute market.
If you are looking to offer goods and services at discount, or subsidized, to fulfill some prioritarian agenda - that's a whole other argument. But the inability to pay is an aspect of the market that has always been at least subconsciously understood.
"We act as if one person who subjectively values an apple more than another person will offer to pay more for that apple, but this of course isn't necessarily true at all."
You're right, they may not - and this certainly would be because of a lack of income. But the price system doesn't include people who really want something, but can't afford it. They turn to some substitute or do without. The price system only records information in a market setting. Those who are unable to enter the market for income related reasons are excluded just as those who are unable to enter the market because of geographic or religious reasons. I never meant to say that the price system could meet the needs of people who desperately want something, but can't afford it. How would that affect my desire for college tuition? Should the price go down, or should we substitute another mechanism (electoral, political, etc.), to ensure I get my college tuition because I really really wanted it?
"How can the market communicate information about subjective valuation if those subjective valuations are mediated through a person's ability to pay?"
ReplyDeleteBecause buyers and sellers in the market are anonymous. They do not have personal descriptors. There is no possible way to tell that the person who bought apples, did so because the store was A) out of oranges, B) the price of oranges was too high, C) personally found apples more pleasing than equally priced oranges, or any number of secondary explanations. But - there is no need for it. By the simple purchase of an apple, the information that an apple has been purchased, at the expense of everything else, has been recorded. Opportunity cost is the only piece of secondary machinery that must be understood. If we accept that people make decisions based on subjective valuations of certain goods, and, that in every purchase there is an opportunity cost - we can logically understand the role of the price system. Which is, a ratio. It is a ratio of the wants of one good to another. As the price system records the information others enter, it necessarily adjusts prices of goods based on demand for goods. Again, if you're looking to modify the price mechanism based on some agenda other than fulfilling what consumers want most, that's another argument. But when I say efficient, I mean from the standpoint of allocating the greatest amount of resources to those who want them the most.
If you haven't read Hayek's famous essay, I would suggest you read The Use of Knowledge In Society.
"If we accept that people make decisions based on subjective valuations of certain goods, and, that in every purchase there is an opportunity cost - we can logically understand the role of the price system. Which is, a ratio. It is a ratio of the wants of one good to another."
ReplyDeleteBut this is my entire concern - it is NOT the ratio of the wants of one good to another. That's what we always assume it is. What it actually is is ratio of the wants mediated through the ability to satisfy those wants of one good to another. Think of it this way - you just won a billion dollars. Your preferences don't change. The preferences of everyone else in the market don't change. But prices are going to change as a result of that, particularly if you live in a small town! But the ratio of wants hasn't changed at all because everyone's preferences have stayed the same. The ability to pay matters.
I don't think it's a major hindrance. As I said, a lot of the ability to pay comes from the price of labor (wages), so from a general equilibrium perspective rather than a comparative statics perspective it doesn't have to be problematic. But obviously not all inequality is due to differences in productivity, so it's still an issue.
"if you're looking to modify the price mechanism based on some agenda other than fulfilling what consumers want most, that's another argument."
ReplyDeleteI'm not looking to do anything in particular - but if I were, the point would be precisely to pursue the agenda of fulfilling what consumers want most, precisely because if this is an issue the market wouldn't be doing that.
We define efficiency the same way - my point is simply that the market doesn't just assign to who wants something the most. You and someone that makes ten times as much money as you may want a good precisely the same. If there's extreme scarcity, the market is going to allocate that good to him, not you, and it has exactly zero to do with "who wants it most" at that point.
I have read the uses knowledge in society and would definitely recommend it to other readers of the blog.
You're forgetting two things.
ReplyDeleteOne, if I won a billion dollars, then whomever I won it from is now a billion dollars poorer. As I spend my billion dollars, and as the other party refrains from spending, prices will rise locally and depress in another area. We have price changes across the board that attempt to show the difference in my ability to pay. One thing you are not considering is that my preferences DO change. Ultimately, the demand for goods in infinite, but when I say subjective valuations (preferences) I am already including my ability to pay. If I am deciding between an apple and a helicopter, and I choose the apple, it is because I cannot afford the helicopter. Once I have the income for it, I may now choose the helicopter. Apples now become inferior goods. You don't keep buying Ramen noodles once your income rises; your preferences change because you can consider more options. The subsequent price changes from winning a billion dollars reflect my new preferences for expensive goods.
Secondly, if we're supposing that we print the billion dollars - then the price changes will also be in flux, like in the previous example, until the correct ratio of goods-to-goods is reached. The prices are attempting to reach equilibrium levels.
If I win money or if it is conjured out of thin air, prices change for two reasons:
1) I, specifically, am able to purchase more expensive goods and so local prices for all goods will change relative to each other. The price ratio of all those goods changes.
2) Price changes as a result of inflation or deflation.
But in both cases, prices change because I am able to purchase goods in higher volume (you get this right) and also because I am able to purchase goods of higher quality (you forget this).
RE: "the point would be precisely to pursue the agenda of fulfilling what consumers want most, precisely because if this is an issue the market wouldn't be doing that."
Again, I ask you: How can you possibly know what consumers want most without resorting to price rationing? How can you possibly know, without asking what they would give up for it? It's impossible.
RE: "You and someone that makes ten times as much money as you may want a good precisely the same."
First of all, I don't believe we can ever make perfect interpersonal utility comparisons (for one good reason, that utility is ordinal, not cardinal) and secondly, the market's allocation of the good to the second man is evidence that he provided an earlier service to warrant purchasing it; he must have earned that money by serving previous consumers.
You're getting mixed up. I'm not suggesting prices and price changes function without any recourse to a person's ability to pay, but I am suggesting that when we use to term preference, we are already including a person's ability to pay as I explain above.
On a final note, Daniel - If we don't use the price system to allocate goods, then we necessarily run into shortages. Demand for goods is infinite, and the price system manages preferences. Without a price system, we must fulfill an infinite amount of wants or we resort to political rationing.
RE: "One, if I won a billion dollars, then whomever I won it from is now a billion dollars poorer. As I spend my billion dollars, and as the other party refrains from spending, prices will rise locally and depress in another area. We have price changes across the board that attempt to show the difference in my ability to pay."
ReplyDeleteThat's fine that they fall somewhere else. The point is, prices are rising and falling because of ability to pay - not because of any change in demand or as you say "wants" at all.
RE: "One thing you are not considering is that my preferences DO change."
Well I abstracted away from that possibility, but it doesn't change anything. If your preferences change then obviously change in prices will reflect both preferences and income - but the point is price changes don't solely reflect changes in the marginal utility derived from a product. Certainly I'm not making the claim that because marginal utility isn't the only thing to impact prices, it never impacts prices. Of course it does - and if your preferences change prices will change too.
Re: "and also because I am able to purchase goods of higher quality (you forget this)"
I'm not sure why you think I forget this - I suppose because I don't mention it explicitly?
You mention inferior and superior goods, and that's an important thing to consider in this case. But ultimately it's a special case where preferences do actually change. Special cases are fine to mention, but we shouldn't pretend they provide an answer on the general case. If we think about a world where preferences stay constant with income (which in a certain realm they obviously do), then the price mechanism does not maximize utility - what it maximizes is utility weighted by income (the utility of people with greater income gets a higher weight than the utility of people with a lower income).
RE: "Again, I ask you: How can you possibly know what consumers want most without resorting to price rationing? How can you possibly know, without asking what they would give up for it? It's impossible."
I agree - did I ever say it was possible? This is why I said I have no agenda for this, except to think about how the market works. But if I were ever motivated to have an agenda, the point is the market does no better at this if I were right.
RE: "First of all, I don't believe we can ever make perfect interpersonal utility comparisons (for one good reason, that utility is ordinal, not cardinal)"
No, utility is cardinal and the market makes interpersonal comparisons of it every day - that's the whole point of the market.
RE: "the market's allocation of the good to the second man is evidence that he provided an earlier service to warrant purchasing it; he must have earned that money by serving previous consumers"
Exactly right - this is the point I've been making about general equilibrium thinking. My point is just that it's ridiculous to think that differences in income are solely due to performance in the labor market (or whatever other market income is earned in) - although that is a major part of it and takes care of a lot of the problem.
RE: "I am suggesting that when we use to term preference, we are already including a person's ability to pay as I explain above."
I agree, but that's the whole problem - they shouldn't be combined like that. They are implicitly combined, but we think about it as if we're only talking about preferences.
As for your final note - don't worry. Nobody here is advocating abandoning the price system. I'm just interested in its workings.
RE: "That's fine that they fall somewhere else. The point is, prices are rising and falling because of ability to pay - not because of any change in demand or as you say "wants" at all."
ReplyDeleteNot because in any change in demand? Demand is willingness and ability to buy. If my income rises and I choose substitutes for my goods, then my ability to pay has changed. Demand IS changed. But you're still not addressing that my preferences change because my income changes. It's a simple question of inferior vs normal goods.
RE: "but the point is price changes don't solely reflect changes in the marginal utility derived from a product."
Not once did I make this claim. I said price changes because of differing subjective valuations - part of which has to do with marginal utility and part of which has to do with a person's income range. My preference for good A already takes into account the marginal utility I derive from it and the price of the good. If it didn't, the price system would have no way of accounting for people who only meet half the demand definition (willingness to purchase). You need full demand to take part in the market (wants and ability to pay).
RE: "If we think about a world where preferences stay constant with income (which in a certain realm they obviously do), then the price mechanism does not maximize utility"
What?? In a certain realm? This doesn't even make sense in a special case. You're confusing your thinking by resorting to some type of aggregative equilibrium analysis. That assumption - that prices stay constant with income - is absurd. If it were true, we could never account for technological advances for everyone would keep buying more volume of a good, not goods of higher quality. Ultimately, preferences are constantly changing, and they change especially when income rises because we can demand (as I defined above) more. Demand changes entirely.
RE: "No, utility is cardinal and the market makes interpersonal comparisons of it every day - that's the whole point of the market."
Wrong. Utility is ordinal because our personal understanding of wants and needs is not specific enough to warrant cardinal numbers. Utility is graded on a scale. Secondly, the market does make utility comparisons, but not PERFECT utility comparisons. Even if we say that total utility is higher when two people trade, nobody can ever be sure which person gained more from the trade. This is where you have to read Mises and Rothbard on this.
RE: "it's ridiculous to think that differences in income are solely due to performance in the labor market"
So maybe it was inherited - which still means that someone previously had served consumers. Unless you're talking about theft (which is a nonmarket action), all exchanges cancel out previous exchanges. All purchases are morally "good" in the sense they clear the existing debt one party had over another.
RE: "I agree, but that's the whole problem - they shouldn't be combined like that. They are implicitly combined, but we think about it as if we're only talking about preferences."
Why shouldn't we explicitly define it like that? Demand combines both marginal utility and ability to pay. That's essentially what we're talking about. It just gets confusing to talk about one side removed from the other; they are, in a very real sense, stuck together.
Re: "Not because in any change in demand? Demand is willingness and ability to buy. If my income rises and I choose substitutes for my goods, then my ability to pay has changed. Demand IS changed. But you're still not addressing that my preferences change because my income changes. It's a simple question of inferior vs normal goods."
ReplyDeletePlease reread - I'm willing to stipulate the existence of inferior goods. That's not the only thing that's going on here. You could remove that assumption of inferior goods - assume no goods are inferior - and you'd get the same effect, which is my point. But if you're saying that demand is both preferences and ability to pay then you already seem to agree with me.
Like I said in an earlier comment, we rarely disagree on fundamentals. It' mostly semantic arguments we're having :)
ReplyDelete