Prices and efficient allocation of goods

Reading: Current Affairs, Do Economists Actually Know What Money Is?

Economics is separated from other social sciences by its use of models. Whereas other social sciences try to gather evidence from the past and present to understand what might occur in the future, economics creates mathematical models to try to show what is likely to occur in the future.

These models rely on prices to achieve efficiency.┬áIf, for example, there was one plank of wood left at Bliffert’s lumber yard, and Derek needed it to finish his house, whereas I only needed it to finish my deck, Derek would be willing to pay more. Since Derek is willing to pay more, he would get the plank, and the plank would go to its most efficient use. Clearly, finishing a house–a basic human need–is more important than finishing a deck, which is a luxury item.

The Price is Right recently came to Milwaukee. If I am willing to pay $50 for a Price is Right ticket, whereas Derek is willing to pay $100 for a price is right ticket, Derek should get the ticket because it is clearly more valuable to him. It is more efficient for Derek to get the ticket since he values it more. If our entire economy obeys prices, we ensure that the people who most want something get it, which leads to a more efficient economy. But if my disposable income is $100 and Derek’s disposable income is $10,000, I actually value that ticket more than he does. I am willing to spend half of my entire disposable income on the ticket, whereas Derek is only willing to spend 1% of his disposable income.

Rather than ensuring efficient allocation of goods throughout the economy, prices ensure that goods tend to be allocated to those with the most money (even if that is not the most efficient use).


Discussion questions:

Open discussion.


Notes from discussion:

This was originally done with the efficient equilibrium hypothesis, but I think this is too much to cover in one discussion.

People talked a lot about natural disasters. This is a very dramatic example of the fallacy of this idea and perhaps should be taken up next time this topic is presented.

Another great point someone made: someone homeless cannot afford a house, yet some billionaire is currently buying their seventh home. This is clearly not efficient.