Markets as a tool for resource allocation

Markets do good things. We don't want to eliminate markets because of the value that they bring in terms of determining how to allocate resources. We don't want to hinder the operation of markets in ways that keep the markets from setting good prices.

So, for example, we don't want to set up situations where a more efficient producer is elbowed out by one of less efficiency because of undue regulation--for example, we don't want some sort of tariff on Acme widgets, just because Acme's competitor is friends with the King (or whatever the government--Adam Smith, from whom the notion of free markets being best is generally derived, was writing about free markets in opposition to monopolies granted by the English government). We would not, in a free market, want to favor some firms because of political connections.

On the other hand, if we are counting on the market to do a good job of allocating resources, we have to have regulations that make sure that resources are being allocated effectively. Perhaps most importantly, we need to be sure that a producer is not able to sell cheaply by avoiding some costs, or by transferring some costs to others. Pollution is a good example: if Acme widgets dumps toxic waste and someone else has to pay for safe disposal, then the market is not correctly valuing the product, and resources are being allocated inefficiently.

Let's talk through an example, imagine that the cost to make up a widget is one dollar--seventy cents of the cost is parts and labor, and the other thirty cents is cleaning up the toxic waste. If Acme widget is actually paying the costs of making the widget, then it cannot stay in business selling for less than one dollar. If they can't stay in business selling widgets for more than a dollar, paying the full costs, then, according to the theory of free markets--the theory of unregulated markets as efficient allocators of resources--, they shouldn't stay in business. If Acme doesn't pay the cleanup costs, however, they can make a profit at a lower cost, and the resources necessary for cleanup do not get factored into the market, and so the market doesn't lead to the desirable outcome.

In short, if you want markets to give good guidance on resource allocation, then it is necessary to have regulations that prevent inefficiency of resource allocation, and it is necessary to eliminate regulations that create inefficiency.

Anyway, despite all the cries for free markets during elections and during debates on legislature to which they are opposed, most of those who have called for free markets have also supported legislation that destroyed the efficiency of market allocation.

Wouldn't it be great if markets did a better job of helping allocate resources?