Saturday, January 12, 2008

Distorted prices

This is another post in my extraordinarily arrogant series about the misuse of economics terminology by economists.

What is price?

In a market with more than one supplier of a commodity or service, and more than one customer for it, it is what people are prepared to pay. More precisely, it is a ratio, something like demand divided by supply, multiplied by at least one constant, the cost of production (while it is easy to sell below the cost of production, that isn't sustainable).

The consequences of the artificial setting of price are well known - too low and there will be a shortage of supply, too high and there will be a shortage of demand. The latter case provides a mechanism for rationing a scarce commodity or service. There is no longer a free market in that commodity, but demand will be reduced.

Every single advocate of road pricing I have read has referred at some point to this being a "market" solution. But it plainly isn't. What's more, this is the case by design. The imposition of a price that will throttle demand is intended to prevent the use of roads from being regulated naturally by anything resembling a market. If you wanted to establish a market solution to road congestion, you would allow people to build roads privately and to charge for them, in competition with one another where possible.

That might not be practical, and it might be that road pricing is the only possible solution. But it is a misuse of the term to suggest it is a market solution. Prices exist within markets. Prices also exist outwith them. To forget this is to forget the elementary logical principle that although all oranges are fruit, not all fruit are oranges.

5 comments:

Tim Worstall said...

Hmm, no.
Markets always exist within constraints. Those constraints can be legally created, by legislation, they can be societally created, they can be created by usage, by precedent, but those constraints are always there.
For example, how can we have a market in land unless we have a generally agreed system of property rights?
So as with road pricing. It is indeed a marketsystem, we're just creating the property rights (the property right to use, for a period of time in return for a rental payment) via legislation.
It's not an unusual finding that even free marketeers like the ASI suggest that the constraints bounding a market be created to include externalities like congestion.
Your earlier one on the way that free markets and capitalism get conflated (wrongly) is spot on.

Peter Risdon said...

A free market is not the same as an unregulated market, and legal support for property rights and the law of contact are not constraints on a market, but rather prerequisites for it.

This is the key paragraph in my post: "The consequences of the artificial setting of price are well known - too low and there will be a shortage of supply, too high and there will be a shortage of demand. The latter case provides a mechanism for rationing a scarce commodity or service. There is no longer a free market in that commodity, but demand will be reduced."

I think you might agree that the former is true, as would most Zimbabweans and Venezuelans. The latter is also necessarily true - it's the corollary of the former. Neither are market solutions.

Road pricing is not a way of creating property rights; it is explicitly a way of rationing a limited resource by the imposition of a price in the knowledge that above a certain level this will throttle demand.

It is not a market system because there is no flexibility of supply.

Peter Risdon said...

Premature eclickulation.

I meant to add that I think the ASI misuse the term in this context (did I mention this was an arrogant series of posts?).

I haven't understood the issue of externalities with this. I'm not sure what they are, except for obvious ones such as the effect for people living on and near congested roads. In what way is my inability to use roads as easily as I'd like, or to get somewhere as fast as I'd like, an externality?

In any event, I'm not arguing that road pricing is wrong, but rather that it isn't a market solution.

Peter Risdon said...

Typo in my first comment:

law of contact = law of contract

dearieme said...

In the EU all carrots are fruit. I find that profound.