Back to Overview
Review Question


Some Qualifications

The discussion of market efficiency rests on many assumptions. Three deserve special notice.

The first is that people are rational, that they know what is best for themselves and act accordingly. If people do not know what is best for themselves or do not act in a rational way to achieve their goals, the whole normative basis for economic efficiency is undercut.

Second, the discussion in the previous selections took place in a static framework in which wants, resources, and technology were held constant. But the most distinctive aspect of a market economy is its dynamic nature. Market economies are constantly changing their environments. In contrast, other economic systems--such as tribal-subsistence, feudal, or centrally planned socialist societies--resist change. Outside forces cause change, not the internal workings of the economic system. Karl Marx may have been the first to recognize the dynamic characteristic of capitalism when he wrote the following in the Communist Manifesto:

"The bourgeoisie has played a most revolutionary role in history. The bourgeoisie, whenever it has got the upper hand, has put to an end all feudal, patriarchal, idyllic relations...The bourgeoisie cannot exist without constantly revolutionizing the instruments of production, and with them the whole relations of society...Constant revolutionizing of production, uninterrupted disturbances of all social conditions, everlasting uncertainty and agitation distinguish the bourgeois epoch from all earlier ones."

The danger of trying to use conditions of efficiency that were developed in static models for policy guidance in a dynamic world concerned Joseph Schumpeter when he wrote the following:

"A system--any system, economic or other--that at every point of time fully utilizes its possibilities to the best advantage may yet in the long run be inferior to a system that does so at no given point of time, because the latter's failure to do so may be a condition for the level or speed of long-run performance."1

Third, consider Jane and Janet, who are very envious of each other. Whatever makes one better off makes the other unhappy. With preferences such as these, the notion of economic efficiency loses meaning because there are no possible moves that are mutually advantageous. Economists have generally dealt with this problem by assuming that preferences of this sort are not legitimate and should be ignored.

Unfortunately, people do have preferences of this kind. Most social sciences other than economics consider the quest for status a powerful motivator. Status, however, is not like normal goods because it is fixed in amount. If one person gains status, someone else must lose it. Everyone cannot be at the top of the social pecking order--someone must be at the bottom. Efforts to gain status may help the individual, but must come at someone else's expense. Pursuit of status leads to a prisoners' dilemma situation.

In his Prices and Choices (Ballinger, 1977) David Hemenway tells a fable of a world in which status is acquired by being taller than average (not unlike the world we know) and in which people determine the height of their children shortly after conception. As people strive to improve the status of their children, they ask for taller and taller children. As a result, the average height of adults shoots up past ten feet. Eventually, the average height is so high that people need braces just to stand up. Clearly, the end result is less desirable than the original. Yet this result comes about through a series of moves that individuals take to improve their own well-being. Although Hemenway's story is fiction, there are cases in which quest for status has resulted in physical mutilation. An important example was feet binding in China, which crippled women for centuries. (How different is some plastic surgery in the contemporary world?)

Although the concept of economic efficiency can survive the introduction of status, pursuit of status complicates its use. It adds a large class of situations in which mutually advantageous exchanges may have socially harmful side effects. Economists have not studied these situations in depth, but have found it easier to ignore the pursuit of status and other interlinked preferences.2

(Two optional sections provide further discussion of markets and efficiency.)

Back to OverviewReview QuestionExplore

1 Capitalism, Socialism, and Democracy, 1946, p 83.

2 An exception is Robert Frank's Choosing the Right Pond. (New York: Oxford University Press, 1985.)

Copyright Robert Schenk