No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Thirteen: Market “Failure” and the Role of the Government 303 benefits is inefficient, since the output is valued less than its opportunity cost. But as we have seen, the price system tends to coordinate production in line with consumer valuations of all goods and services—all goods that are valued more than their costs are produced, and all units that are valued less than their cost are not produced. As we learned earlier, this is what is meant by allocative market efficiency. As an important reminder, the supply and demand framework is conceptual and shows tendencies, not specific results. We learned in our study of the dynamic world of the market process—which works through real time and the presence of uncertainty—that we don’t have a supply or demand curve; we have data on trades that take place at a certain point in time. Nevertheless, the conceptual framework of supply and demand allows us to evaluate policies in situations where our ceteris paribus assumption is a reasonable one. For some goods and services, efficiency isn’t necessarily guaranteed. This is especially so when we consider the social implications of market transactions. Just as with Achan’s sin, there may be others affected than just those directly involved in a market transaction. Now that we’ve reviewed what is right about markets, let’s see what can go wrong! EXTERNALITIES: NOISE POLLUTION! When you or I make a market purchase, we are usually pretty satisfied with the purchase. I buy a new song on iTunes after I’ve listened to a preview and enjoy streaming it over bluetooth in my car while driving to work. Apple is happy—they received 99 cents (or $1.29) for the song—and I’m very happy—I have the song. So I’m happy, and Apple’s happy—who’s not happy? Well, if I was still a college student, my roommate might not like me playing Karen Carpenter, while I may not feel like the Ty Brasel songs coming from the room across the hall! With nice ear buds we may not have any conflict, but for some reason the 20-year-old in the car next to me seems to greatly enjoy sharing his boom bah boom bah boom with every car within two blocks of him. I can assure you I had no desire to be a part of his market transaction! Yet, the consumption of his legal product (to include not only the music, but the huge sub-woofer and killer on-board electronics) causes me pain—my welfare is certainly reduced by him exercising his freedom. Until now, we’ve assumed that market outcomes were efficient. Every voluntary trade by definition means that both the buyer and the seller believe they will each be better off with the exchange than without it, at least ex ante (before the trade). Since there is a difference in valuation between two goods (usually money and whatever good is being purchased), value is always created by exchange. However, we have only concerned ourselves with the valuations of the two parties to exchange. There are others that are affected by many exchanges. In some cases, perhaps their valuations should be