Knowledge And Decisions

A theoretically perfect economy, operating with unlimited knowledge, no external costs or benefits paid for outside the units that created them, and no monopoly or government intervention, would achieve an optimal allocation of resources under existing technological constraints. With higher technological levels, there would be more output and more satisfaction of tastes, but there is some optimum level and mixture of output for each level of technological possibilities. The existence of a market — that is, the possibility of uncontrolled exchange at the option of the transactors — means that if A could be made better off by changing his mixture of goods, services, leisure, assets, etc., without making B, C, or D, etc., any worse off, he and the other parties who have what he wants could swap to their mutual advantage. If A can be made better off by $2.00 worth, without making B any worse off, then he can make it worth B’s while to swap by offering him a dollar extra and keeping a dollar for himself.

There has, of course, never been any such ideal economy under capitalism, socialism, feudalism, or any other system. The concept does, however, serve as a benchmark by which to (1) measure the performance of one economy against another, and against its own performance at other times, and (2) to pinpoint the reasons why particular activities, institutions or policies do or do not lead toward the theoretical optimum.

Government constraints on the terms which individual transactors can choose among for themselves tend to reduce the number of transactions desired and carried out. If there are various possible sets of transactions terms which would be mutually acceptable to A and B, there is likely to be a smaller set of terms simultaneously acceptable to A, B, and C — where C is the government. As the government adds its own set of prerequisites to those of the negotiating parties, the number of negotiations that result in mutual agreement is almost certain to decline. Various forms of government price control, minimum wage laws, interest ceilings, etc., reduce the number of mutually desired transactions — which are the only kinds of transactions actually carried out in a voluntary, market economy. The government may determine and decree a “living wage” under a minimum wage law, but unless the worker actually finds an employer willing to pay him that much, he will remain unemployed with a hypothetical right.

Similarly, either an individual monopoly or a collusion of buyers and sellers acting in concert may set prices that are not mutually acceptable to as large a number of potential transactors as under competition. The real harm done by such monopolistic combinations is not so much in setting their own terms for transacting, but in being able to forcibly preclude other potential transactors from entering the competition to offer more advantageous terms. Without the power to exclude others, monopolistic negotiators would soon find themselves with competitors and without the transactions they need for their own economic well-being. Business must be able to keep out imports, restrict the entry of competing firms, or make price-cutting illegal. Labor unions must be able to blockade “scabs,” boycott nonunion output, or keep teenage potential competitors out of the labor market with child labor regulations and compulsory school attendance laws. It is not in setting their own transactions terms — which they could never persist in, in the face of unlimited competition — but in forcibly precluding others that monopolistic organizations (business or labor) lead the economy away from its optimal performance.