Social Efficiency

Measuring Value

An obvious question that might arise is, “How are social values of different outputs and inputs established?” After all, consumers are unlikely to have identical tastes and preferences, while workers, landowners, and other suppliers of inputs are likely to differ in their skill levels and other endowments. Hence, members of society will differ in their individual valuations of the many different outputs and inputs that characterize economies. In capitalist economies, the forces of supply and demand establish the values of outputs and inputs. Specifically, market-clearing prices, that is, prices that equate supply and demand, ordinarily serve as measures of value. The reliance on market-clearing prices as measures of social value can be conceptually justified by acknowledging that buyers should be willing to pay, at a maximum, what any quantity of a good is worth to them rather than go without that good. This implies that the market demand curve for a good should represent the valuation that consumers, in the aggregate, place on different quantities of the good. Similarly, sellers should be willing to supply to buyers any given quantity of a good only if the price received at least covers the incremental cost of supplying that quantity. This, in turn, implies that the market supply curve for a good can be taken to represent the incremental cost of supplying different quantities of the good in question. Under reasonable assumptions, the market demand curve is presumed to be downward sloping, while the market supply curve is presumed to be upward sloping.

If markets function reasonably well, prices will adjust so as to equate supply to demand. Under several specific assumptions that will be discussed in the next section, the market-clearing price that equates supply to demand can be taken as a measure of the value that society places on the last unit of output produced and consumed. This is because, as noted above, the demand curve is an expression of the monetary value that consumers place on various amounts of a good. At the same time, the market-clearing price also measures the incremental cost of producing the last unit of output sold, since the supply curve is a schedule of the incremental cost of producing various amounts of the good in question. Hence, the market-clearing price establishes the monetary value of the marginal unit of any product and equates that value to the incremental cost of producing the marginal unit. This analysis applies equally to products sold for final consumption or for use as inputs in further processing activities.

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