Efficient performance with inefficient pricing: a puzzle for economists who believe in the free market

by Charles Wolf, Jr.

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The "puzzle" for economists who believe in the free market is presented in the form of three propositions: (1) Subject to familiar and generally reasonable assumptions, efficient use of resources requires prices of outputs to be equal to marginal costs. (2) Yet many firms in the U.S. often, and perhaps usually, do not set prices equal to marginal costs. (3) Nevertheless, there is a widespread belief (probably shared by many who would accept Propositions 1 and 2), that the market system and private enterprise are more efficient than non-market systems (e.g., centrally planned economies like the Soviet Union) and non-market enterprise. A solution to the puzzle is presented, focusing on non-pricing efficiencies which redeem the market systems, and non-market inefficiencies which plague non-market systems.

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