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Saturday, July 01, 2006

Who to Invite to the Party?

Suppose you have four good friends you would like to invite to a baseball game but, unfortunately, you only have two extra tickets. The tickets were given to you by your boss and they're great seats. It's an important game, so demand for tickets is high and all four would really like to go.

This is, of course, the fundamental economic problem - how to allocate limited resources. There are lots of ways to solve this problem. You could:

Flip a coin.

Remember that two of your friends went with you last month, so to be fair, you ask the other two.

Choose the two you like the best just like always.

Choose the rich one, because he always buys food at the game and dinner afterward, and the poor one because you know he'll appreciate coming along.

Send a group email saying the first two people to reply get to go.

Worried about hurting feelings, and after not being able to decide for several days what to do, you give up and scalp the tickets.

Or, you could use the price system. That's how we choose to allocate most goods in the U.S., and in competitive markets the price system produces an efficient outcome. But there are exceptions such as national parks where we choose to set price low enough so that few are excluded from enjoying the good or service. That is, equity -- giving everyone a fair chance to enjoy the park -- takes precedence over efficiency. In these cases, price is often set below the market-clearing level, and lotteries, first-come first-serve, reservation systems, etc. are used to limit usage to the available supply of spaces.

Using the price system you could send an email again, but this time tell your friends that whomever bids the most gets to go. They can offer to drive, buy concessions, give you cash, whatever they like -- the highest monetary valued bid wins. With any luck, the bids will come in over what you paid for the tickets and you can make a profit. If you choose this method of allocating the goods, you're pretty sure your poor friend won't get to go. But hey, that's the market, right?

There are some goods that are allocated by means other than the price system. If water ever gets so expensive the poor can't afford it, then we'd have to allocate water resources in some other way (even now, drinking water is made available for free from public fountains). Same with health care, same with food, same with other necessities, and the same with things like camping in the forest, going to a museum, fishing, and going to the beach.

When the good is, say, water and the price is low enough so that everyone can afford what society considers to be an adequate amount without breaking their budget, we are comfortable with the price system as an allocation mechanism. But when the necessities of life or other goods we believe ought to be available to most people become unaffordable due to the high prices needed to clear the market, we intervene into the marketplace (e.g. housing vouchers for the poor, public beaches).

As we continue to privatize government services, I hope we will keep in mind who we are excluding when we place the allocation under the jurisdiction of the price system and make the appropriate policy adjustments. Efficiency is desirable, but it's not our only goal.

    Posted by on Saturday, July 1, 2006 at 02:43 AM in Economics, Policy | Permalink  TrackBack (0)  Comments (12)

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