Efficiency and inequality

Most of us are familiar with fundamental concepts of supply and demand. We tend to consume more of an item when its price falls, and vice versa. The price, in turn, represents the intersection of supply and demand.

Suppose that an area experiences drought, which is most of California these days. One way to induce conservation of water is to increase its price—to reflect lower supply. People in the aggregate respond by using less water.

But there are exceptions. Rich households will probably continue their water-consumption behavior, unaffected by rising prices. Poor households, on the other hand, will very likely cut back on their use of water. They simply cannot afford to pay higher water bills.

The U.S., as we should all know by now, is the most unequal modern industrial society in terms of wealth and income. Very wealthy Americans have so much money that they literally could not possibly spend it all. Meanwhile, the Rest of Us struggle to make ends meet.

In a market-based economy such as ours, in which pricing dominates, the poor will suffer more than the rich in nearly every respect, and even more so when the price of an essential commodity like water rises.

This recent article in Vox provides some insight into efficiency and inequality. Author Matthew Yglesias writes:

When economic inequality is really severe, using prices to regulate the distribution of scarce goods can be seriously unfair. At the same time, using non-price mechanisms can be seriously inefficient.

That means that inequality is preventing us from adopting efficient solutions to a wide variety of problems, ranging from drought response to traffic congestion to climate change.

In countries with lower inequality (he cites Norway and Sweden) price mechanisms work better and more fairly than in those countries with greater inequality like the U.S. Charging motorists to enter urban cores during peak hours will reduce congestion, but in America the reduction will come at the expense of the poor; the rich will pay the higher cost with little or no impact on their overall consumption of goods and services.

Yglesias concludes:

To the extent that inequality undermines arguments for efficient price-based schemes, the correct conclusion is to reject inequality, not reject pricing.