Prices: Incentives and Communication Device

Prices, queuing, and coupons all can ration goods, but there is more to an economic system than rationing. Incentives and information are needed to get goods produced. Prices can provide both, whereas queuing and coupons provide neither. If a society tries to eliminate money and prices entirely, it will have to find not only an alternative method of rationing, but also an alternative method of giving incentives. There is good reason to believe that alternative methods of incentives will be morally repugnant to many people.

It may be possible to solve the incentive problem with coercion. Studies of slavery indicate that it was a profitable system in the old South, and studies of the concentration camps of Nazi Germany and Stalinist Russia will probably show that they too were profitable--that is, they produced more than it took to maintain the camps. (However, these systems appear profitable only because they ignore the costs imposed on those who are coerced, an omission most of us find unacceptable.)

There is still another problem of doing away with price and money. They not only give incentives, but they also provide a convenient way to summarize information to decision makers about wants and availability of goods. To see this, consider a commodity, say copper. The supply and demand model may only approximate this market because there are only a few producers, but the approximation is probably fairly good.

Suppose that a new use is developed for copper that will use 10% of available supply. The demand curve for copper will move to the right, causing price to rise, which tells users that copper now has increased value elsewhere and that they should try to cut back. The rise in price will tell producers that they should try to produce more and will reward them if they do. Hence, if an important new use for copper is developed, it is not necessary for either producers or users to know what it is. Prices give them all the information they need to know to conduct their affairs.

Or, suppose that a major new source of copper is found. This will cause the supply curve to shift right and price to fall. The lower price tells buyers that the resource is now more abundant relative to its uses, and that they should consider using more copper. The message the lower price gives to producers is that they should consider reducing their efforts to produce copper because their efforts are now of less value, and they should consider shifting resources into other lines of production. There is again no need for any producer or consumer to know the details of the new supply. Prices tell them all they need to know to make correct decisions.

To better understand how price allocates, let us see what an economy looks like when it tries to function without price rationing or allocating.

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Copyright Robert Schenk