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I was reading a paragraph in an economics textbook that was talking about resource allocation, and felt that it missed an important point, leading to a conclusion that I disagreed with. I was hoping that someone could either explain why I'm wrong, or point me to alternate resources that talk about this facet of the problem.

My textbook asserts that a competitive market would produce an efficient allocation of resources. Resources would be moved from less profitable products to more profitable ones, and this would necessarily increase the monetary value to consumers of the total products sold.

I understand the reasoning, but I question that total monetary value to consumers can be related to total satisfaction of consumers when applied to a large populace.

I accept the implicit assumption that the amount a single actor is willing to pay for something would be directly proportional to the amount of satisfaction they expect to get from it, but don't think this property can't be generalised to a system of people with different total wealth.

As an example, a beggar would not be willing to spent \$30 on a good steak dinner while a millionaire might. One would not reasonably use this fact to argue the millionaire gains more satisfaction from the meal than the beggar, but rather that it would require more expected satisfaction to get a beggar to part with \$1 than a millionaire.

Applying this observation to how markets determine a price, we can see that a products price (and by extension its profitability) is not solely determined by its utility. Rather it reflects the products utility combined in some way with the wealth of its consumers. A simplistic view might say

(price a consumer is willing to pay) = (wealth of consumer)*(expected satisfaction)

and so

(price of a product) = (wealth of consumer base)*(expected satisfaction)

In the above both the price and satisfaction represent their marginal values.

Working from that conclusion we can say that while allocating resources from a less profitable product to a more profitable product will increase the monetary value of products sold to the entire populace, we say the same about the total satisfaction of the populace. It may simply be that this moves satisfaction from a poorer section of the populace to a richer section.

i.e. in a situation where different products can be supplied to different sections of the populace, a products price can no longer be used to directly infer its utility. Hence optimising for monetary value to all consumers is not necessarily optimising for total consumer satisfaction.

Just to note: The paragraph in the textbook never explicitly drew a conclusion between monetary worth to all consumers and total satisfaction, but there were phrases like "\$20 worth of consumer satisfaction". It's this conflation between satisfaction and monetary value over an entire populace that I don't follow.

EDIT: I re-read my question, and thought I didn't make it clear what I was asking:

It's:

1) Is there an obvious flaw in my argument?

2) If not, does anyone know of textbooks/articles that look into this (especially any that include data).

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  • $\begingroup$ I'm not sure about this: "allocating resources from a less profitable product to a more profitable product will increase the monetary value of products sold to the entire populace". If the nation's supply of paper was used in the highly profitable book industry until books started being delivered electronically at which point the resource was shifted to paper towels, how can we say paper towels are "more profitable"? And how does that change the monetary value of products sold to the entire population, since they are still paying for books (presumably)? $\endgroup$ – CWill Jul 21 '17 at 12:14
  • $\begingroup$ The way I understand the argument, is that once people start reading electronic books the profitability of creating new books decreases (i.e. a business converting paper to books will not make as much profit). $\endgroup$ – Apple Jul 22 '17 at 14:58
  • $\begingroup$ (accidentally commented early -- Pressed Return to add newline). Say the new price is \$b_new per \$x worth of resources (paper & wages & ...) at previous production levels. If, this price is lower than the current market price of towels per \$x in resources (\$t) (more profitable), then reallocating \$x worth of resources would reduce the total value of books sold by \$b_new and increase the value of towels sold by \$t. As $\$t > \$b_new$ more monetary value is produced. Once resources are reallocated the prices will change. $\endgroup$ – Apple Jul 22 '17 at 15:16
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My textbook asserts that a competitive market would produce an efficient allocation of resources. Resources would be moved from less profitable products to more profitable ones, and this would necessarily increase the monetary value to consumers of the total products sold.

The textbook is correct (provided the assumptions behind "competitive market" and other implicit ones hold).

First, assume the distribution of wealth is given. Then, based on their budget constraint, consumers will have a certain demand for goods. Firms will compete for such demand, offering the lowest price that earn them an economic profit. In competitive markets, such profits are zero. Resources are allocated such that consumers are maximising their utility at the given prices. The allocation is Pareto Optimal.

This result is summarised in the First Welfare Theorem.

Second, through some form of lump-sum taxation, we could redistribute wealth in order to change that allocation. A competitive market will make the equilibrium Pareto Optimal too. This is the Second welfare theorem (see link above).

So, your intuition that the wealth/income distribution affects prices and the final allocation is correct. But the key to allocative efficiency is in the mechanism (market), not in what is being allocated.

I hope I am answering your questions.

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