Allocating goods by ability and willingness to pay isn’t a perfect method of distribution, but it has important advantages over the alternatives.

The Price System and Distributive Justice

Steven Horwitz is Economics Editor at Lib​er​tar​i​an​ism​.org and Distinguished Professor of Free Enterprise at Ball State University. Horwitz has written extensively on Austrian economics, Hayekian political economy, monetary theory and history, and macroeconomics.

One of the most common complaints against markets is that allocation by price, or by willingness to pay, is somehow unfair. Why should those who are willing or able to pay whatever the price is for a particular good be the only ones who get it? Aren’t there other, more fair or more moral ways to allocate goods, especially things that people think of as “necessities?” One particular area we see this argument made is with respect to health care, where the fear is that only the rich would be able to afford certain kinds of procedures or treatments. Another place we see this sort of argument is over what we might call “emergency pricing.” The case for laws against so‐​called “price gouging” plays to similar fears and similar notions of fairness.

If we think even more broadly, we can imagine all kinds of ways other than price that we might allocate a supply of goods. Imagine a big, but limited, pile of some good sitting outside waiting to be distributed among an even larger number of demanders. How might we do so other than by price? Some obvious candidates come to mind. We could, for example, use a lottery system and only those whose numbers get called get the good. Or we could say only those with birthdays on even numbered days (or odd ones) get the good. We could, as many nominally socialist economies did for decades, use a queueing system and just hand out the good until the supply is exhausted. Those early enough in line would get the good.

We could also allocate by “need.” Imagine people having to fill out some sort of application to obtain the good and a panel of experts deciding whose need was greatest, with the good going to those with the greatest need until the supply was gone. Or finally, imagine “Fight Club.” One way to allocate goods is “might makes right.” Just let the assembled crowd fight it out and those who are the strongest or quickest or best armed will get the good, while the weaklings go home empty handed.

It’s easy to point to the problems with these ideas. Aside from the damage to persons and property from Fight Club, it will lead to people devoting an increasing amount of resources to acquiring weapons or ways to defend themselves. All of that resource use represents a loss to society (what economists would call a “deadweight loss”) compared to a world in which such expenditures were not necessary. So, while it can indeed allocate goods, Fight Club does so at a very high social cost. (One might note the parallel between Fight Club allocation and the rent‐​seeking process by which economic actors expend and waste resources to persuade political actors to grant them privileges or impose costs on their competition.)

Allocation by need might sound good on paper, but how exactly one would define “need” and how such a panel of experts would assess it are problems, as is the opportunity for favoritism and nepotism that such an arrangement would create. Is there any reasonably objective standard of need that we could rely on? Queueing systems favor those with time on their hands, and various randomization or lottery schemes do not ensure that those who get the good are those who might put it to the most valuable use. This is a point often raised about price controls during emergencies: by keeping prices artificially low, the existing supply often ends up being put to uses of far less importance than if people had to pay the market clearing price. If you are lucky enough to find bottled water at the controlled price, you might well use it to water your plants or wash your dog. At the higher market clearing price, you’d purchase less and skip those uses and conserve it for drinking or bathing perhaps, and leave more for others to do the same.

All of these are real problems with non‐​price allocation processes. But as I noted at the start, price allocation is not perfect either. It does tend to mean that at any point in time, the good is more likely to end up in the hands of those with more ability to pay. Some will always see that as unfair. So, what do we do? How might we choose among these imperfect processes? And why believe that price allocation is still better?

The answer is that price allocation has one enormous advantage that all of the other methods lack. And that advantage is somewhat obscured by the way I set up the problem. By imagining a pile of goods waiting to be distributed, we overlook the question of what causes those goods to come into existence in the first place. The advantage of allocation by price is that changes in prices provide the signal and the incentive that (potential) producers need in order to know that they should produce the good in question. All of the other methods take the supply side of the market as given and focus on how to ration goods among demanders. Only allocation by price links the method of distribution to the problem of production. Price, as every introductory economics student learns, links together demand and supply.

Increases in demand that drive up the price of the good signal to producers that the good is being valued more highly and that they should produce more of it. Declines in demand that reduce prices signal the opposite. In both cases, that signal also works as an incentive to engage in the appropriate response. Backing up a step, the whole reason that people will produce the good in the first place is because they think they can obtain a price for it that will make it worth their while to do so. The pile of goods doesn’t appear by magic – it requires that someone somewhere knows that the good is desired, that they have an incentive to produce it, and that they can figure out how best to do so. That knowledge and the accompanying incentives are provided by prices. None of the other allocation processes ensure that there will be a supply of goods to be allocated! For example, once we give away the good through a lottery, why should we expect that more of the good will be forthcoming in the future?

It’s often hard to respond when critics of markets complain about what they see as the unfairness of allocation by price, especially with things like medical care.

The case against laws prohibiting price gouging makes this point clear in a more specific context. As noted earlier, one advantage of letting prices rise during an emergency like a hurricane is that it forces people to use the limited supply of the good only for its most important purposes. But there is a second advantage of letting the price rise. The higher price provides a signal and incentive for other suppliers to move more of the good to where the hurricane has hit. Not only does this bring in more goods to be purchased in the short run, over time, it drives the price back down from the temporary heights caused by the emergency. No other way of allocating the limited supplies of goods after the hurricane can do that. The lesson we learn from emergency pricing is just an application of a more general point about allocation by price.

It’s often hard to respond when critics of markets complain about what they see as the unfairness of allocation by price, especially with things like medical care. It does libertarians no good to deny that there are imperfections with price allocation. It’s true that it does make it easier for the rich to get things, at least in the short run. But that imperfection has to be weighed against the substantial advantages associated with price allocation, particularly the way in which prices provide the signal and incentive necessary to produce goods and services in the first place, not to mention the innovations that characterize market‐​driven economies. All of that increase in production and all of those innovations work to the benefit of everyone, but especially the least well‐​off who have seen the cost of all kinds of “necessities,” including health care, fall over the last several generations. And those falling prices have made more and more things accessible to more and more people in ways that alternative systems have not.

Although willingness and ability to pay may seem unfair at any point in time, allocation by price is the only method available to ensure a continual supply of better and cheaper goods and services for more people over time. And that makes markets and allocation by price arguably more fair and more moral than any of the alternatives.

Dedication

I’d like to dedicate this piece to the late Walter E. Williams, whose principled and courageous applications of the economic way of thinking, and whose ability to communicate those ideas so effectively to broad audiences, remain sources of inspiration to me and so many other economists.