Standard textbook economic theory teaches that efficiency requires price equal to marginal cost, and in long run equilibrium, price also equals average cost. In a perfectly competitive market, this holds.

Yes, but the real world doesn’t quite conform to standard textbook theory.

A monopolist claims part of the “consumers’ surplus” by taking account of demand, setting marginal revenue equal to marginal cost.

‘Part’? A monopolist can claim all of the consumer surplus, no?

But the real question is: why would efficiency be maximum when the entire surplus is shifted to the consumer, and there is no producer surplus?

You said earlier

Prices are supposed to be related to costs in order for an economy to operate efficiently

… rejecting the notion that the value (as perceived by the buyer) should play a role in price setting. How do you apply that in, for example, the following markets?

  • Land
    A square metre of land in central London is worth a large multiple of a square metre on a remote Scottish island. Is that price determined by the cost, or by the value? If the latter, does that mean the market in land is fundamentally and irretrievably inefficient?
  • Commodities
    The price of a kilo of coal, aluminium or gold bears almost no relationship to the cost of mining and refining it. Is it not determined largely by the perceived value the buyer attributes to it? Is the market in commodities inefficient? Is it monopolistic?
  • Labour
    A shelf stacker earns an equivalent hourly wage that is less than that of a primary school teacher, whose hourly wage is less than that of a Tube driver, who earns less than an oil rig worker, who earns less than a senior management consultant, who earns less than a FTSE-100 Finance Director. Is the wage differential a matter of cost (borne by the worker, as a supplier), or of the value they provide to their employer (as the buyer)?
    You may also want to consider transactions which are commission based. Are real estate agents operating in a monopolistic, inefficient market? Despite the availability of fixed cost alternatives, they do seem to thrive — how else is that possible than because they buyers of their services perceive value in excess of the cost?
  • Artists
    Since you mention Taylor Swift, I’d be interested in your explanation of her income, compared to that of the busker I saw last night in a London Underground station. Is it as a result of cost, or of perceived value? Should she lower the ticket prices for her concert, and the price of her albums so that it is brought in line the cost associated with the production — with only consumer surplus, and no producer surplus?

Ticket scalping

This is a really interesting one. By definition, the right to attend a concert is a scarce good. How, in an efficient market, would you ensure maximum welfare, without taking into account the perceived value of a concert ticket? Clearly, if the tickets were priced as you appear to advocate (based only on cost), the demand would vastly outstrip the supply. What would be the right way of allocating the available tickets to an audience that might be an order of magnitude (and possibly more) larger than there is availability?

Accidental behavioural economist in search of wisdom. Uses insights from (behavioural) economics in organization development. On Twitter as @koenfucius

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