Last semester I took a Principles of Economics class. On the final, there was a question about a bridge that a company was considering building. The bridge had a large fixed cost, but required no variable cost. The question gave a demand schedule. Based on the demand schedule, there was no price that would make the bridge profitable.
If you calculated the consumer surplus for the bridge with a price of 0, it was greater than the cost of the bridge. The answer the professor was looking for was that the government should build the bridge and provide free access.
I was wondering, what is the Austrian Economics solution to this type of problem? If the free market would still provide the bridge, how would it do it? If really precise price discrimination was possible, I could see the company providing the bridge. If it’s not possible, how would the bridge get built?
If the project is profitable then the government doesn’t need to do it; the private sector will. If the project isn’t profitable than no one needs to do it; it’s just a waste of scarce resources, a malinvestment. The answer to this question becomes obvious once you understand what profit is.
There are a lot of products that won’t make profit - no matter what the price may be - due to the lack of demand. If the demand isn’t there, why make it?
If the project is profitable then the government doesn’t need to do it; the private sector will. If the project isn’t profitable than no one needs to do it; it’s just a waste of scarce resources, a malinvestment. The answer to this question becomes obvious once you understand what profit is.
Say the bridge costs $2.1 million, and this is the demand schedule:
Price
Quantity Demanded
$7
150,000
$6
200,000
$5
300,000
$4
400,000
$3
600,000
$2
800,000
$1
1,000,000
$0
1,150,000
No price will cover the $2.1 million cost. BUT, if you add up how much all the consumers value the bridge, using the price they’re willing to pay, you get a total value of…
150,000 * $7 = $1,050,000
50,000 * $6 = $300,000
100,000 * $5 = $500,000
100,000 * $4 = $400,000
200,000 * $3 = $600,000
200,000 * $2 = $400,000
200,000 * $1 = $200,000
$3,450,000
That means if the bridge was provided for no fee, there would be a total consumer surplus of $3,450,000, which is greater than the cost of $2,100,000.
At no individual price point was the bridge profitable, but the benefits of building the bridge still outweigh the costs.
How can you say a “total consumer surprlus” is indicative of “benefit” to the market? The end result seems to be something like total potential revenue.
Why is this unique to public goods? It should work for IPODs too.
The model seems to be exploiting the fact that the owners can’t charge multiple prices for their goods. But actually, they can and do all the time. Intel sells Dell processors cheaper than anyone else on the market. The only issue is transaction costs.
But the argument from government makes the assumption that we can benefit from providing the road. If that’s true, then acquiring (partial) ownership of the economy should be possible too. For example, if the road would boost the town’s economic performance 20%, you could just buy enough baskets-of-shares in the town to where the increase in value of shares covers the cost of the road - you wouldn’t even need to charge a toll for it…
In short, the model assumes a certain production and distribution strategy. This is just another “the market is too stupid to adjust” argument.
The government solution would necessarily be sub-optimal for people only willing to pay a few dollars in toll for the bridge. The $7 people would win, and the $1 people would lose. The key fault is in the aggregating of individual price-functions as if they are utility functions. Interpersonal comparisons of utility are lol. One solution isn’t “better” than another. The market has to demonstrate through action what the best allocation of resources is.
The government solution also neglects political costs of getting the government to do what you want it to do. I don’t see why, since statists talk about market transaction and information costs all day, then turn around and assume government is a magic wand.
The example is nonsensical. Of course quantity demanded rises as price lowers, but that doesn’t mean resources have been efficiently economized throughout the economic system. It only means that more important satisfactions were abandoned in order to appropriate the necessary resources towards the construction of a less important satisfaction.
I think you missed the point. The question is not about the downward sloping demand curve… It is about consumer surplus being higher than the costs for a project, but the project still being unprofitable.
That, I definitely see. Using taxes to build the bridge is definitely unfair for the people in the community who would never use the bridge. However, my question is not about the morality but of the efficiency.
Can you elaborate? I’m intrigued. Aren’t prices the means of valuation in the economy?
I’m not making an argument from fairness. I’m identifying that some people win, and some people lose. So what’s the net gain? You have to make interpersonal comparisons of utility, which is impossible.
The market solution is the only one where people demonstrate through action that they prefer the good at a certain price, while others are free not to purchase it. Rothbard called this “demonstrated” preference. Hypothetically, the purchase could have negative psychic effects on other members of the population. For example, homosexual relationships. But since the rest of the population has (from hypothesis) decided not to participate, their preference goes “undemonstrated”, and remains a speculative thought experiment.
Prices are ONE means of allocating goods and services. You can also allocate goods non-monetarily. For example, there is a free market in sex.
Furthermore, they are not used as “valuation” in the economy, since valuation is subjective. Example, I value wildflowers and sunsets.
Hopefully the government is building a bridge to get out of town. There is an obvious reason why people won’t pay for an unprofitable bridge that MUST be built. To tax the majority of people who prefer some other good or service, say bread, to the bridge had better hope that the “efficiency” of the project is of such nature: That the bridge helps to get them out of Dodge quicker. If not, then the 200, 000 poor SOBs who could afford $1 and bread and the 150, 000 poor SOBs who could only afford bread, certainly not $2 and bread, are SOL when the government taxes them into starvation.
That means if the bridge was provided for no fee, there would be a total consumer surplus of $3,450,000, which is greater than the cost of $2,100,000.
I am assuming that the 3.45 million is the revenue from a graduated income tax. Sieben hits the nail on the head: Your example assumes that in a free-market, producers can’t sell to different consumers at different prices. The example, then, is based on a fallacy to “prove” the market incapable of what only the government can do through a graduated income tax.
The question seems to assume that the bridge should or must be built. Why is that?
An important question to consider is why the company is considering building the bridge. Would the bridge aid the company in other operations? If so, profitability of the bridge per se doesn’t matter, as it’s an investment the company is making to further its overall business.
Otherwise, if the company wants to build the bridge solely to make money from people using it, one would expect it to build the bridge in a location that it expects to be profitable. Based on the demand schedule given, the bridge would not be profitable, so it wouldn’t be built.
We thus return to the question of why must the bridge be built anyway. Your professor seems to consider the people in that area to be somehow entitled to the bridge. What’s his reasoning for that?
I can’t make sense of your example. If the equilibrium price was $3, “consumer surplus” would equal 1,200,000 [7-3 = 4; (4(600,000).5)]. But all of this is entirely superfluous (in fact, it’s meaningless).
Here’s a few things to consider:
“Consumer surplus” only exists when you make it exist in theoretically untenable models. In other words, there is no “consumer surplus” in the real world. Value can not be broken down into individual and calculable components. Value is only graded and never measured; it’s a list (not a geometric area). If the project is unprofitable than it is simply not warranted; the resources required for such an investment would be better employed in some other area. You must consider the opportunity cost.
You must differentiate between accounting profit and economic profit. The fact that a project earns, for example, a 2% rate of return, does not mean that it’s profitable (economically speaking). It would have negative economic returns, expressed by a negative “producer surplus” (in a perfectly competitive market producer surplus would be zero).