I had a rather unsettling thought recently, and I'd like to run it by
the ARMCHAIR group and see if any of you can tell me if this is (a)
correct and well-known, even if I somehow missed it (citations
please!), (b) completely wrongheaded (reasons please!), or (c) correct
and actually new. Keep in mind as you read this that I'm a very
free-market-oriented economist. Don't think, when you get to the
fourth paragraph, that I'm advocating socialism. I'm not. Here goes:
It's a basic teaching of economics that in a free-trade environment,
resources will be used for their highest-values use. (The version of
this that says "In the absence of transaction costs..." is known as
the Coase Theorem.) In other words, if a particular piece of property
produces more income (net of other inputs) as a farm than as a
shopping center, it will be used as a farm rather than a shopping
center regardless of who owns it initially, since a farmer will be
willing to pay more for it than a shopping-center developer. This
always holds, unless there is either some enforceable law preventing
the highest-valued use, or if transaction costs of transfering it from
it's current (or next-highest-valued) use to its highest-valued use
exceed the incremental value of that use.
My thought is: This is all fine when the resource concerned is used to
make money, but what if it's used for direct consumption? For
example, suppose there is a large four-bedroom house on a nice lot for
sale in a nice neighborhood. A two-income couple with no kids may
well be able to outbid outbid a one-income family with five kids
(raised by the parent who would otherwise be able to earn another
income), who may in turn be stuck in a three-bedroom cramped townhouse
because of their lower household income. But, is that really a
higher-valued use?
Normally, we assume that the "value" of something is what somebody is
ready, able, and willing to pay for it. The fact that the childless
couple offers to pay more "proves" that the large house is worth more
to society in their hands than in the hands of the large family. But
if the two households were forced to trade houses -- putting the
childless couple in the smaller house and the large family in the
bigger house -- would total utility increase? If total utility is a
monotonic function of per-capita square footage -- which "sounds"
reasonable -- the answer is yes. If this is the case, it means the
market is NOT allocating resources to the highest-values use.
The normal way out of this situation is to appeal to the fact that we
can't make inter-personal comparisons of utility. That is, a given
consumer's utility function is good for ordering THAT consumer's
preferences (you value this item more than that item), but it tells us
nothing about one consumer's valuation compared to another consumer's
(do you value this item more than the next guy? we can't know). This
is not just a statement that utility functions are highly personal --
it's actually a necessary consequence of the axioms we think utility
functions ought to satisfy (and assume they do satisfy). Those axioms
imply that any monotonic transformation of a utility function is
equivalent to the original utility function -- that is, you can't
multiple your utility function by five and then claim you value
everything five times higher than you used to.
The problem with this appeal is that it doesn't really solve the
problem. To the contrary, it basically says YOU CAN'T SOLVE THE
PROBLEM. You can't say that the house is worth more to the larger
family than the small one based on per-capita square footage (since
you can't compare one family's valuation of square footage with the
other's) -- but you ALSO can't say the the house is worth more to the
small family than the large one based on willingness/ability to pay,
(since you can't compare one family's valuation of money with the
other's).
In other words, if this is right, the Coase Theorem does not hold for
consumption goods -- it holds only for goods that are used to generate
income.
Furthermore, if this is right, we CANNOT say that a free market
allocates consumption goods to their highest valued use. We can say
that about income-producing goods, but not consumption goods. If we
say it about consumption goods by defining the value of consumption
goods as willingness-to-pay, we are implicitly comparing utility
across consumers -- which violates the axioms of utility functions.
That is, we are comparing utility across consumers in a completely
arbitrary way. Because utility functions are only defined up to a
monotonic transformation, there is no principled basis on which to say
that willingness-to-pay is a more valid basis for comparison across
consumers than family size, age, willingness-to-pay as a percentage of
income or wealth (instead of as straight dollars), or shoe size.
This is unsettling for several reasons. First, it partially
undermines one of the main free-market arguments. While it doesn't
actually advance a socialist give-the-big-family-the-big-house
arguement, it undermines one arguement against that theory. Second,
it implies that the Coase Theorm is inconsistent with consumer theory,
and that our treatment of consumption goods has to be significantly
different from our treatment of goods used as inputs to production.
Mostly, we treat the two of them the same, and view profit as the
"utility" of a producer. But if this analysis is correct, profit and
utility are actually different in a fundamental way.
Thoughts?
--Robert Book
[EMAIL PROTECTED]
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