Is the Market a Test of Truth and Beauty?

Ȇȇ Partʺ: Economics

paid for the commodity on the basis of marginal-cost pricing will thus

fall short of total costs. But since price should equal marginal cost, the

industry should run at a loss, and the government should make up the

loss out of general taxation.

Alfred Marshall had already in hisPrinciples(ȀȇȈǿ/ȀȈȁǿ, pp.ȃȅȈ–ȃȆȂ)

championed subsidies to decreasing-cost industries in the old-fashioned

language of “consumers’ surplus.” In recent years Harold Hotelling (ȀȈȂȇ,

pp.ȁȃȁ–ȁȅȈ) and Abba Lerner (ȀȈȃȆ, esp. pp.ȀȈȃ–ȀȈȈ) have insisted vig-

orously on the proposition; and though the conclusion is startling, the

Hotelling-Lerner logic, summarized above, seems impeccable.

Ļe disconcerting thing is that another chain of reasoning leads to a

seemingly opposite conclusion. R.H. Coase (ȀȈȃȅ, pp.ȀȅȈ–Ȁȇȁ, esp. p.ȀȆȁ)

states two principles of optimum pricing:

Ș.For each individual consumer the same factor should have the same

price in whatever use it is employed. Otherwise consumers would not

be able to choose rationally, on the basis of price, the use in which they

preferred to have the factor employed.

ș.Ļe price of a factor should equate its supply and demand and should

be the same for all consumers and in all uses.

From these principles Coase draws the implication that the amount
paid for a product should be equal to the total value that the factors used
in its production have in another use or to another user. In other words,
the price of a product should be equal to its full cost.
Coase argues that if certain factors of production can be obtained free
in one use (because they do not enter into marginal cost), but have to
be paid for in another use (because they do enter into marginal cost),
then consumers may choose to employ these factors in the use in which
they are free, even though they would in fact prefer to employ them in
some other way. If the Hotelling-Lerner solution were adopted, there
would be only one way out of the difficulty. Ļat would be for the state
to decide whether or not each consumer should be supplied with the
particular good in question. Ļis would be done by estimating whether
or not each consumerwouldbe willing to pay the full cost of supply-
ing him if he were called upon to do so. Coase further argues that no
government could estimate individual demands accurately; that if all pric-
ing were on a marginal-cost basis, there would be less information avail-
able by which such an estimate could be made; and that the incentive