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Rationing and Prices

March 5, 2012

Rationing is the allocation of a fixed quantity of a good. Efficient rationing distributes the good to those who value it highly and denies it to those who do not. In a market system, the exact quantity of any particular good is not fixed. A shortage implies that demand exceeds supply. To a layperson, that means that there isn’t enough of the good. To an economist, that means the price isn’t high enough to clear the market. High prices simultaneously reward more production and penalize excessive consumption. While scarcity is not optional, there are several margins people can substitute across. The market allocates goods within markets, between markets, and between production and leisure in general.

Within a Market
At the high end of the demand curve are those who have a high “willingness to pay“. Those willing to pay more than the marginal cost of production will get the good; those who are not, will not. Now, there are issues about whether some people deserve welfare and whether those who are rich earned their money fairly, but in an idealized market, goods are allocated efficiently by the price mechanism. In the real world, markets do a pretty darn good job of this task, but this type of allocation has more government intervention than the other types of allocation.

Between Markets
For several different goods, production will be guided by the relative values which people place on them. So, if people place high value on health care, more resources will go into health care, rather than, say, housing or clothing. When you go to the store and buy a good, you are simultaneously allocating more of that good to yourself, and allocating more resources to producers of that good, causing society to make more of it.

Work and Leisure
Finally, there is issue of allocation between work and leisure of producers. If everyone worked 80 hours a week, people would have tremendous material wealth, but they would have little time to spend on leisure. When the price of a good gets bid up due to a demand shock, it increases the wages of people who produce that good. They may decide to increase their work effort to earn more money, thus expanding the capacity of the economy as a whole. When people discuss rationing, they rarely consider the work/leisure margin, and erroneously assume total economic production is fixed.

Example: Health Care
There are many problems with the allocation of health care in our current system. People are given treatments they don’t need in order to boost insurance payments and government subsidies. Much is wasted on ineffective end of life care. When people talk about rationing health care, they often conflate efficient allocation of a given quantity of health care with the calculation problem of how much health care to produce relative to other categories of goods. There has been much wailing and gnashing of teeth over the fact that health care has expanded as a fraction of GDP over the years. Given increasing wealth and income over time, perhaps health care *should* constitute 30% or even 50% of GDP. Finally, perhaps the market should respond to the baby boomer retiring by vastly expanding the number of hours worked by younger generations, particularly those in the medical profession. There is no way to know, except by observing the emergent patterns of choices made by individuals.

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