An excerpt:
Let’s consider another common case about which many economists differ with views that might be characterized as “populist”. Suppose there is a limited, inelastic supply of road-lanes flowing onto the island of Manhattan. If access to roads is ungated, unpleasant evidence of shortage emerges. Thousands of people lose time in snarling, smoking, traffic jams. A frequently proposed solution to this problem is “congestion pricing”. Access to the bridges and tunnels crossing onto the island might be tolled, and the cost of the toll could be made to rise to the point where the number of vehicles willing to pay the price of entry was no more than what the lanes can fluidly accommodate. The case for price-rationing of an inelastically supplied good is very strong under two assumptions: 1) that people have diverse needs and preferences related to the individual circumstances of their lives; and 2) willingness to pay is a good measure of the relative strength of those needs and values. Under these assumptions, the virtue of congestion pricing is clear. People who most need to make the trip into Manhattan quickly, those who most value a quick journey, will pay for it. Those who don’t really need the trip or don’t mind waiting will skip the journey, or delay it until the price of the journey is cheap. When willingness to pay is a good measure of contribution to welfare, price rationing ensures that those more willing to pay travel in preference to those less willing, maximizing welfare.
Unfortunately, willingness to pay cannot be taken as a reasonable proxy for contribution to welfare if similar individuals face the choice with very different endowments. Congestion pricing is a reasonable candidate for near-optimal policy in a world where consumers are roughly equal in wealth and income. The more unequal the population of consumers, the weaker the case for price rationing. Schemes like congestion pricing become impossibly dumb in a world where a poor person might be rationed out of a life-saving trip to the hospital by a millionaire on a joy ride. Your position on whether congestion pricing of roads, or many analogous price-rationing schemes, would be good policy in practice has to be conditioned on an evaluation of just how unequal a world you think we live in. (Alternatively, maybe under some “just desserts” theory you think inequality of endowment in the context of an individual choice is determined by more global factors that justify rationing schemes that are plainly welfare-destructive and would be indefensible in isolation. I, um, disagree. But if this is you, your case in favor of microeconomic market-clearing survives only through the intervention of a very contestable macro- model.)
Inequality’s evisceration of the case for market-clearing does not require any conventional market failures. We need not invoke externalities or information asymmetries. The goods exchanged can be rival and excluded, the sort of goods that markets are presumed to allocate best. Under inequality, administered prices might be welfare maximizing when suppliers are perfectly competitive (a price floor might be optimal) or when demand is perfectly elastic (in which case price ceilings might of help).
But this analysis, I can hear you say, cruel reader, is so very static. Even if the case for market-clearing, or price-rationing, is not as strong as the textbooks say in the short run, in the long run — in the dynamic future of our brilliant transhuman progeny — price rationing is best because it creates incentives for increased supply. Isn’t at least that much right? Well, maybe! But there is no general reason to think that the market-clearing price is the “right” price that maximizes dynamic efficiency, and any benefits from purported dynamic efficiency have to be traded off against the real and present welfare costs of price rationing in the context of severe inequality. It’s quite difficult to measure real-world supply and demand curves, since we only observe the price and volume of transactions, and observed changes can be due to shifts in supply or demand. To argue for “dynamic market efficiency” one must posit distinct short- and log-run supply curves, a dynamic process by which one evolves to the other with a speed sensitive to price, and argue that the short-term supply curve over continuous time provides at every moment prices which reflect a distribution-sensitive optimal tradeoff between short-term well-being and long-run improved supply. If not, perhaps a high price floor would better encourage supply than the short-run market equilibrium, at acceptable cost (as we seem to think with respect to intellectual property), or perhaps a price ceiling would help consumers at minimal cost to future supply. There is no introductory-economics-level case to establish the “dynamic efficiency” of laissez-faire price rationing, and no widely accepted advanced case either. We do have lots of claims of the form, “we must let XXX be priced at whatever the market bears in order to encourage future supply”. That’s a frequent argument for America’s rent-dripping system of health care finance, for example. But, even if we concede that the availability of high producer surplus does incentivize innovation in health care, that provides us with absolutely no reason to think that existing supply and demand curves (which emerge from a crazy patchwork of institutional factors) equilibrate to make the correct short- and long-term tradeoffs. Maybe we are paying too little! Our great grandchildren’s wings and gills and immortality hang in the balance! Often it is simply incorrect to posit long-term price elasticity masked by short-term tight supply. The New Urbanists are heartbroken that, in fact, the supply of housing in coveted locations seems not to be price elastic, in the short-term or long. Their preferred solution is to cling manfully to price rationing but alter the institutions beneath housing markets in hope that they might be made price elastic. An alternative solution would be to concede the actual inelasticity and just impose price controls.
Let’s consider another common case about which many economists differ with views that might be characterized as “populist”. Suppose there is a limited, inelastic supply of road-lanes flowing onto the island of Manhattan. If access to roads is ungated, unpleasant evidence of shortage emerges. Thousands of people lose time in snarling, smoking, traffic jams. A frequently proposed solution to this problem is “congestion pricing”. Access to the bridges and tunnels crossing onto the island might be tolled, and the cost of the toll could be made to rise to the point where the number of vehicles willing to pay the price of entry was no more than what the lanes can fluidly accommodate. The case for price-rationing of an inelastically supplied good is very strong under two assumptions: 1) that people have diverse needs and preferences related to the individual circumstances of their lives; and 2) willingness to pay is a good measure of the relative strength of those needs and values. Under these assumptions, the virtue of congestion pricing is clear. People who most need to make the trip into Manhattan quickly, those who most value a quick journey, will pay for it. Those who don’t really need the trip or don’t mind waiting will skip the journey, or delay it until the price of the journey is cheap. When willingness to pay is a good measure of contribution to welfare, price rationing ensures that those more willing to pay travel in preference to those less willing, maximizing welfare.
Unfortunately, willingness to pay cannot be taken as a reasonable proxy for contribution to welfare if similar individuals face the choice with very different endowments. Congestion pricing is a reasonable candidate for near-optimal policy in a world where consumers are roughly equal in wealth and income. The more unequal the population of consumers, the weaker the case for price rationing. Schemes like congestion pricing become impossibly dumb in a world where a poor person might be rationed out of a life-saving trip to the hospital by a millionaire on a joy ride. Your position on whether congestion pricing of roads, or many analogous price-rationing schemes, would be good policy in practice has to be conditioned on an evaluation of just how unequal a world you think we live in. (Alternatively, maybe under some “just desserts” theory you think inequality of endowment in the context of an individual choice is determined by more global factors that justify rationing schemes that are plainly welfare-destructive and would be indefensible in isolation. I, um, disagree. But if this is you, your case in favor of microeconomic market-clearing survives only through the intervention of a very contestable macro- model.)
Inequality’s evisceration of the case for market-clearing does not require any conventional market failures. We need not invoke externalities or information asymmetries. The goods exchanged can be rival and excluded, the sort of goods that markets are presumed to allocate best. Under inequality, administered prices might be welfare maximizing when suppliers are perfectly competitive (a price floor might be optimal) or when demand is perfectly elastic (in which case price ceilings might of help).
But this analysis, I can hear you say, cruel reader, is so very static. Even if the case for market-clearing, or price-rationing, is not as strong as the textbooks say in the short run, in the long run — in the dynamic future of our brilliant transhuman progeny — price rationing is best because it creates incentives for increased supply. Isn’t at least that much right? Well, maybe! But there is no general reason to think that the market-clearing price is the “right” price that maximizes dynamic efficiency, and any benefits from purported dynamic efficiency have to be traded off against the real and present welfare costs of price rationing in the context of severe inequality. It’s quite difficult to measure real-world supply and demand curves, since we only observe the price and volume of transactions, and observed changes can be due to shifts in supply or demand. To argue for “dynamic market efficiency” one must posit distinct short- and log-run supply curves, a dynamic process by which one evolves to the other with a speed sensitive to price, and argue that the short-term supply curve over continuous time provides at every moment prices which reflect a distribution-sensitive optimal tradeoff between short-term well-being and long-run improved supply. If not, perhaps a high price floor would better encourage supply than the short-run market equilibrium, at acceptable cost (as we seem to think with respect to intellectual property), or perhaps a price ceiling would help consumers at minimal cost to future supply. There is no introductory-economics-level case to establish the “dynamic efficiency” of laissez-faire price rationing, and no widely accepted advanced case either. We do have lots of claims of the form, “we must let XXX be priced at whatever the market bears in order to encourage future supply”. That’s a frequent argument for America’s rent-dripping system of health care finance, for example. But, even if we concede that the availability of high producer surplus does incentivize innovation in health care, that provides us with absolutely no reason to think that existing supply and demand curves (which emerge from a crazy patchwork of institutional factors) equilibrate to make the correct short- and long-term tradeoffs. Maybe we are paying too little! Our great grandchildren’s wings and gills and immortality hang in the balance! Often it is simply incorrect to posit long-term price elasticity masked by short-term tight supply. The New Urbanists are heartbroken that, in fact, the supply of housing in coveted locations seems not to be price elastic, in the short-term or long. Their preferred solution is to cling manfully to price rationing but alter the institutions beneath housing markets in hope that they might be made price elastic. An alternative solution would be to concede the actual inelasticity and just impose price controls.
RSS Feed
