Rationing

Economics concept #13

Imagine for a moment that everything is free. For the moment we won’t worry about who’s going to produce it without being compensated. What happens?

By now it’s probably obvious: the amount demanded increases dramatically. After all, the number of people willing to pay $2 for a dozen eggs, or $12 a pound for steak, or $400 for the latest game console, is nothing compared to the number of people who will take it if it’s free.

Where would all this free stuff come from? Remember opportunity cost: every bit of feed that the chickens eat is gone forever. Every acre used to raise beef cattle is an acre that’s not available for something else. Every gram of 99.9999%-pure monocrystalline silicon that goes into a game console is one gram less that can be used to produce other electronics.

In other words, even if we leave out the issue of humans expecting to benefit from work they do and risks they take, we run into the problem of scarcity. In economics, that word refers to the fact that there aren’t enough resources to produce all the goods and services that everyone wants. There must be some kind of rationing mechanism, a way to determine who gets what.

If you ask people to come up with a rationing mechanism themselves, many will say something like “whoever needs it the most should get it.” And that’s a morally good approach, but outside of a small community where we know (sort of) everyone’s needs, it’s not possible on a practical level. If we’re talking about thousands, or millions, or billions of people, measuring each one’s level of need for each good or service simply can’t be done accurately even if the person doing the measuring is honest. There’s also the fact that we’re not talking strictly – or even mostly – about needs here. The vast majority of goods and services are things people want but don’t need. Who would get how much of all of those?

Instead, at least for most goods and services, individual traders use price as the rationing method: the people who get a particular good or service are the ones willing to pay the equilibrium price. And because each individual is trying to increase their own utility, but must increase their trading partner’s utility to make that happen, the result is increased overall utility. A seller is generally not thinking “how can I allocate my goods in a way that maximizes total economic surplus?,” but “at what price do I maximize my profits by selling all of my goods without leaving money on the table by charging too little?” Likewise, a buyer doesn’t think “which potential purchase results in the highest overall economic surplus?,” but “how can I get the most value for my money?”

But in both cases, the two questions have the same answer. Entirely without meaning to, participants in a free market – a market in which buyers and sellers agree together on the terms of their trades without an outside party interfering – help each other by pursuing their own self-interest. If we’re going to step outside of economics proper and consider ethics, this is probably the most ethical approach possible. Each person follows their own self-interest instead of being forced to act according to someone else’s priorities. That’s not to say it’s a perfect system - it has one significant flaw that we may go over much later - but for large numbers of people, it’s the most efficient and beneficial system humanity has come up with so far.

Leonard Reed’s educational essay “I, Pencil” (definitely worth a read even if it’s several decades old) popularized early economist Adam Smith’s idea of an “invisible hand” that guides markets toward beneficial outcomes, but that’s only a metaphor. There is no hand. People frequently refer to “the economy,” but “the economy” has no mind of its own. It has no needs, no wishes, no objectives. It does not want to do or try to do anything. It’s simply a shorthand way to refer to a huge number of individuals, working for their own benefit and in the process benefiting others.