In neoclassical economic theory, the rationing function of price apportions commodities to the individuals willing to pay the most for them. If willingness to pay reflects value, then the rationing function of price maximizes value across all consumers. The allocative function of price apportions factors of production to whatever industry is able to pay the most for them, which in theory is the industry that adds the most value to the factor, maximizing value across all producers. If we accept that willingness to pay reflects value, then markets maximize the value of both inputs and outputs. However, it is not at all clear to some of us that willingness to pay actually reflects value. Consider the following case study, which you can read about in more detail here.

Aventis developed a compound, eflornithine, with promising pharmaceutical characteristics. Scientists discovered in 1979 that the compound killed trypanosomes, the parasite responsible for African sleeping sickness, a contagious and debilitating disease transmitted by the tsetse fly. Since 1970, an epidemic of the disease has threatened 70 million Africans. Although the only other treatment for second-stage sleeping sickness is extremely painful to administer, often ineffective and often lethal, Aventis could not profit from selling the drug to poor Africans and discontinued production for that purpose. At the same time, however, Bristol Myers Squibb (BMS) and Gillette were producing eflornithine to remove unwanted facial hair in women, a very profitable enterprise. Aventis and BMS agreed to again produce eflornithine for the treatment of African sleeping sickness only after the NGO Médecins Sans Frontières threatened to publicize the issue (Gombe 2003; WHO 2006). Had the market been left to its own devices, the rationing function of price would have continued apportioning eflornithine to the individuals who value it the most in economic terms, which is to say rich hairy women rather than destitute Africans. The allocative function of price still apportions far more resources toward industries that supply cosmetics for the rich rather than those that supply cures for lethal diseases that afflict the poor. Although most people would presumably think saving lives is a more valuable use of resources than developing cosmetics, markets allocate resources toward those who have money and unmet wants, not toward those who have unmet needs. The allocative and rationing functions of price were working as intended. Was value maximized?

There is one more part to this story. Markets fail when resources are nonrival. Something is nonrival if use by one person does not leave less for another person to use, which is certainly true for information. Although the marginal value of a rival resource is determined by the greatest amount any individual is willing to pay for the last unit provided, that of a non-rival resource is determined by the amount all beneficiaries together are willing to pay for one more unit. With the exception of patented information, virtually all non-rival resources are also non-excludable, and if individuals will be able to use the resource whether or not they pay for it, they have little incentive to pay or even to divulge their true willingness to pay. As explained above, one function of price is to ration the use of resources, but if use of a non-rival resource does not diminish the quantity available, if use provides utility, and our goal is to maximize utility, then using prices to ration consumption is irrational. In other words, although markets lead to the suboptimal supply of nonexcludable resources, they lead to the suboptimal demand for non-rival resources. If the ‘recipe’ for eflornithine is patented, patent owners can charge a monopoly price. If the ‘recipe’ is freely available to all, companies will compete to see who can produce it at the lowest cost. Which approach do you think would create most value?