There's a classic Econ 101 brainteaser often posed
in introductory economics courses (I think I saw it first in Steve Landsburg's work),
which I won't quote verbatim, but it's along these lines:
Question: Suppose apples are produced by a competitive industry, while pears are provided by a monopolist. Coincidentally, they both sell for the same price, and you would be equally happy with either. If you care about conserving societal resources, which should you buy?
Answer: You should buy the apple if you care about economic efficiency and conserving societal resources. In a perfectly competitive market, firms produce up to the point where price equals marginal cost (P = MC). This means that the price of an apple reflects the true societal cost of the resources required to produce it.
I hope that makes sense because, by contrast, a monopolist typically restricts output and sets a price above marginal cost (P > MC). This results in underproduction - some consumers who would have been willing to buy at a price above MC are unable to do so, leading to deadweight loss. This artificial scarcity means society is not producing as much as it efficiently could, making the monopoly inefficient from a resource allocation perspective.
Since the price of an apple equals its marginal cost, choosing an apple means you are participating in a market that operates efficiently, ensuring that goods are produced at the optimal level. By contrast, choosing a pear supports a monopolistic market structure that produces inefficiently low quantities, reinforcing the misallocation of resources. Thus, if your goal is to align your purchasing decision with economic efficiency and the best use of societal resources, you should buy the apple.
At first glance, the idea that a seller in a competitive market sells at a price equal to marginal cost (P = MC) does seem counterintuitive - it almost sounds as if they are only breaking even on the last unit produced. However, there's more to the story, because we are considering average cost as well as marginal cost. Marginal cost is the cost of producing one additional unit, but average cost is the total cost (including fixed costs) divided by the number of units produced. In a perfectly competitive market, the price is typically equal to both marginal cost and the minimum average cost in the long run. This ensures that firms cover all costs, including fixed costs, and earn a normal profit, which is the minimum return necessary to keep a business operating in the industry.
That's also why, in the long run, in a market-friendly industry with no barrier to entry or excessive regulations, competitive firms earn this normal profit but not excessive profits, because competition drives prices down to the level of average cost, but not below it. Incidentally, it also shows the foolishness of the statement 'people before profits', to which I can refer you in past blogs (see here and here).
The fact that it's usually better to consume from a competitive industry than a monopoly (natural monopolies sometimes excepted) also shows why it's usually better for the market to provide goods and services than the state. Markets are competitive industries but governments are monopolies. In competitive markets, firms must minimise costs and innovate to survive. This tends to allocate resources efficiently, leading to lower prices and better quality for consumers. Competitive markets produce goods where the price reflects the true societal cost of resources, ensuring that production aligns closely with consumer preferences. And markets tend to adjust quickly to changes in demand or supply, as firms compete to attract customers and maximise profits.
Governments, which are de facto monopolies, usually lack incentives to innovate or reduce costs because they do not face direct competition. And government-provided goods and services usually do not reflect true marginal costs, due to subsidies, taxes, or inefficiencies - meaning an almost inevitable over- or under-consumption of resources.
In his famous dictum, The Four Ways to Spend Money, Milton Friedman outlined the perennial problems of governments spending someone else's money on someone else - the typically least efficient way that money is spent. It's obviously not the case that markets are always preferred over governments in every sector - but politicians are primed to put their own interests first, which means the probability of inefficiency and bad value for money increases. I'll elaborate on that in tomorrow's blog post.
