Prices and the Efficient Allocation of Resources

Just how important are prices anyways?  Can resources be efficiently allocated without them?  What percentage of activities have actual price tags?

Wake up or sleep in? Price tag? No.
Put on clothes? Price tag? No.
Brush your teeth? Price tag? No.
Shave? Price tag? No.
Use the toilet? Price tag? No.
Go for a jog? Price tag? No.
Take a shower? Price tag? No.
Eat breakfast? Price tag?  No.
Brush your teeth?  Price tag?  No.
Put on deodorant?  Price tag?  No
Go to Starbucks? Price tag? No.
Buy a cup of coffee?  Price tag?  Yes.

Clearly the vast majority of our allocation decisions do not have literal price tags.  But they do all have an opportunity cost.  Each use of a resource requires that you sacrifice all the alternative uses.  Every course of action requires the sacrifice of all the alternative courses of action. This means that resources are put to their most valuable uses when individuals have the freedom to choose which uses they value most.  Therefore, it really does not seem that prices are necessary in order for resources to be efficiently allocated.

I might be wrong though.  But because I'm a pragmatarian...it's not necessary for me to be 100% certain one way or the other.  This is because if prices are truly necessary...if they facilitate the creation of more value...then if congress lowered the tax rate, taxpayers would give them more of their taxes.  A lower tax rate would mean a larger private sector (prices) and a smaller public sector (no prices).

Even though it's purely academic in nature, it's quite enjoyable to discuss the feasibility of pragma-socialism.  Pragma-socialism is a pragmatarian system with a 100% tax rate.  Maybe it's pretty much the same thing as a market economy without any prices.  Every organization would be a non-profit...but you could choose which non-profits you donate to.

Over on Peter Boettke's blog entry... ABCT Providing the Missing Gap...I've been discussing the topic with Nicholas (also his comment on the pragmatarianism FAQ).  As a result of our discussion, I think it would be informative if he could try and quantify exactly how necessary prices are to ensure the efficient allocation of resources.  So I created the following graphic...

Here's my answer... A-0, B-7.5, C-8.  From my perspective, there's a huge disparity in the allocative efficiency between planned economies and market economies...and little, if any, of that has to do with prices.  It simply has to do with the fact that in a planned economy people's preferences are either assumed, or disregarded.  As a result, how society's limited resources are used (the supply) does not reflect the actual demand for goods/services.  When individuals do not have the freedom to decide which uses of their limited resources they value most...it's a given that resources will not be put to their most valuable uses.

However, from Nicolas' perspective (and the perspective of most/all free-market economists), the disparity in allocative efficiency between planned economies and market economies is in no small part due to the presence of prices in market economies.  Therefore, my guess is that he'll place B on anywhere from 3 to 5 on the allocative efficiency scale.

Anybody is welcome to share the graphic that I created and repost it elsewhere.  Also, for more discussion on the topic just google "A World Without Prices or Profit" and "A Survey on the Importance of Prices".

[Update]

Other blog entries on the topic...

Hey Mungerfesto, Prices OR Consumer Sovereignty?
Prices vs Chips

Frequently Asked Questions (FAQ)

Here are some answers to frequently asked questions regarding pragmatarianism (tax choice).  I've selected the Environmental Protection Agency (EPA) to be my default example.

Wouldn't important government organizations be underfunded?

This is logically impossible because "importance" can only be determined by how much an individual is personally willing to sacrifice for something (opportunity cost).  If many taxpayers give a significant amount of their own tax dollars to the EPA then, and only then, could we say that protecting the environment is important to the American public.

Wouldn't taxpayers have to be better informed for this to work?

If environmentalists and the EPA have a good reason to believe that the environment should be a higher priority for taxpayers...then it would be their responsibility to share their information with taxpayers.  With the current system, taxpayers can't choose where their taxes go...so it would be pointless for them to make the effort to learn about the environment or the EPA's efforts to protect it.  Therefore, pragmatarianism would eliminate rational ignorance.

How would it work?

At anytime throughout the year you could go directly to the EPA website and make a tax payment of any amount.  The EPA would give you a receipt and you'd submit all your receipts to the IRS by April 15.  Anybody who didn't want to shop for themselves would have the option of giving their taxes to their impersonal shoppers (congress).

How specifically could taxpayers allocate their taxes?

The granularity would be determined by the EPA and its supporters.  The greater the granularity, the less control the EPA would have, but the greater its knowledge of taxpayers' environmental priorities.  Any disparity in environmental priorities would reflect disparities in information.  Taxpayer choice would increase information intercourse.  

How would the tax rate be determined?

Congress would still be in charge of the tax rate.  If they set the tax rate too low...or too high...then they would lose funding.  This is because taxpayers would boycott congress if they weren't happy with the tax rate.  For example, if the tax rate was 40%, but taxpayers derived 60% of their value from the public sector, then they would be unhappy with the tax rate.  If congress wanted to earn more money, then they would increase the tax rate.  So the optimal tax rate would be the rate at which congress maximized its funding.  For more info please see Tax Choice Tax Rate.

Wouldn't this give too much influence to the wealthy?

Creating a market in the public sector would show us the exact percentage of the population that gives their taxes to the EPA. If this percentage is too small (insufficient demand breadth), then taxpayers would no longer have the option of giving their taxes to the EPA.  Therefore, in a pragmatarian system, the wealthy would only be able to fund truly public goods (goods that are broadly beneficial).  This means that pragmatarianism would eliminate the problem of concentrated benefits and dispersed costs.  For more info please see...Visualizing And Evaluating The Public Goodness Threshold.

Parrot Sovereignty

In this thread... Pseudo-demand, Pseudo-supply...Silknor wrote...

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That has virtually nothing to do with what I was asking. So lets rephrase. You have the option of living in two societies:
#1 The US as it is now.
#2 InequalityLand. Here, 1% of the population is incredibly wealthy, another 2% are comfortably middle class, and 97% live in abject poverty. But the overall level of production and wealth is 10% higher than in #1.

It's clear that the InequalityLand ranks higher on efficiency (must be all those socialist redistributive policies in the US, holding their efficiency down). Now, if you can pick which society you'd prefer to live in, but you don't know where in the wealth distribution you'll end up (we'll assign you at random), which would you pick?

Personally, I would pick #1. Would you? And if you would as well, why in the world would we approach economic policy caring only about efficiency and consumer sovereignty. So, what's your true preference? The more efficient society? Or the less efficient but more equitable one?

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My reply...

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This reminds me of a terrible critique of pragmatarianism written by two anarcho-capitalists... Pragmatarianism Disproved. It made me laugh because they attempted to demonstrate how a pragmatarian system with a 100% tax rate wouldn't work. But when I asked them to explain how we would end up at a 100% tax rate...they were unable to do so.

How does consumer sovereignty lead to the second option?

Here in Southern California it's kind of the coolest thing. We have flocks of wild parrots that have completely naturalized. Have you ever heard a flock of wild parrots? It's pretty much the noisiest thing. Especially at the butt crack of dawn right outside my open bedroom window when they are swarming the large fig tree that's weighed down with a ton of ripe fruit.

There the parrots are...happy as can be...squawking and squawking and chowing down on fig after fig. Then, in a flash of green, they fly off to who knows where. Maybe to another fig tree? Surely my fig tree can't be the only fig tree that they visit. I wonder how many fig trees they visit? But wherever they go, they deposit fig seeds. During fig season...what's the average amount of seeds that each parrot poops out? What percentage of seeds actually germinate and make it to maturity?

I wonder if you can already see my point here. I'm talking about parrot sovereignty. With this process at work...how could we end up with fig trees that did not match the preferences of the parrots? Why would the parrots eat figs that didn't match their preferences? How could uneaten seeds possibly be dispersed? Given that no two seed grown fig trees are exactly alike, wouldn't the parrots prioritize and eat the figs that provided them with the most bang for their buck?

I'm sure you've heard the expression..."as happy as a kid in a candy store". That expression is applicable to the parrots during fig season. Why is the kid in the candy store so happy? Because there are so many items that match his preferences. Why are their so many items that match his preferences? Because he has the freedom to choose whichever candies match his preferences and candy makers are free to innovate and offer newer types of candies. Less wonderful candies are replaced by more wonderful candies...it's creative destruction that results in more and more value.

Basically, consumer sovereignty will lead us to heaven on earth. Except, not in your scenario. What gives? The next time you're at the mall...step back, sit down and pay attention to the throngs of consumers picking x or y. You won't be the only one doing so. If producers want consumers' money...then they are going to have to produce items that are closer matches to the preferences of consumers.

Am I wrong? Perhaps. If so, then please walk me through a step by step process showing exactly how consumer sovereignty leads us to society #2.

In The Future We're All Going To Be Light Brown and Bisexual

Is that true?  It came up on page six of this post...Pseudo-demand, Pseudo-supply.