The argument for the efficiency of the perfectly competitive market is familiar: large numbers of firms selling an undifferentiated product will compete price to marginal cost, ensuring that everyone who can afford to pay the cost of production gets access to the product.
But is the distribution of wealth between buyers and sellers that is created by marginal cost pricing fair?
Today, economists agree that the distribution of wealth created by marginal cost pricing is entirely arbitrary. For the distribution of wealth is determined by inframarginal units of production, not marginal units. The benefit to me of the tenth unit of production of a particular good might be $10, and that might be just equal to the marginal cost of producing the tenth unit, making the market price under perfect competition in turn $10. But the gain I get from buying all ten units is determined by the value to me of each of the first nine units I purchase, not the marginal tenth, and the value I get from the first nine may be very much higher than $10. If I get $20 of enjoyment from each of the first nine units, then my gain from my purchase of ten units, net of the price of $10 that I pay for each unit, is $90. If the marginal cost of production is a constant $10 over all units, the gain to the producer is $0. That’s hardly fair to the producer. All of the gains from trade, defined as the difference between the value conferred on consumers by production and the costs of that production, go to me. Even though price is set equal to marginal cost.
It is for this reason that a century ago economists rejected the promotion of competition as a means of guaranteeing a fair distribution of wealth. They embraced competition because it is efficient–I am able to purchase every unit for which I am willing to pay the cost of production, so the economy produces all of the gains from trade of which it is capable–but they recognized that some other means was needed to achieve a fair distribution of wealth. That other means was the tax system. Raise my taxes by $45 and reduce the producer’s by $45 and now the gains from trade are distributed equally between us.
Given our current understanding of the distributive importance of inframarginal units of production, it is startling to discover that a century ago John Bates Clark, a giant of conservative economics, made a vigorous case not just for the efficiency but also for the distributive justice of perfectly competitive markets. His distributive case was rejected almost as soon as it was made, and has since sunk into obscurity. But that leaves me wondering: How could Clark have been unaware of the fact that the distribution of wealth is determined by inframarginal units, not marginal units? Did he just not understand marginalist economics? The few contemporary scholarly discussions of Clark’s work that I have encountered fail to explain.
The answer, it turns out, is that Clark understood marginalism, and the argument that inframarginal units determine the distribution of wealth. But he thought he had a convincing rejoinder. Here he is in his magnum opus, The Distribution of Wealth:
The man that we are studying is a society in himself: he makes things and he alone uses them. [The value to him of the last unit that he produces] measures the effective utility of everything that he makes. Though [the value to him of the first unit that he produces] may measure the absolute benefit conferred by the loaf that satisfies hunger, the real importance of having that loaf is far less. If this necessary article were taken away, the man would devote a final hour to bread-making, and would go without the article otherwise secured by that final increment of work. Destroy his day’s supply of food, and what he goes without will be luxuries naturally secured by the terminal period of labor. [The value to him of the last unit that he produces] measures the utility of those luxuires, and it measures therefore the effective service rendered by the supply of necessaries that are produced in an equal period of work. Any [inframarginal unit] will have a true importance measured by [the value to him of the last unit that he produces]; since, if it were lost, there would be diverted to the replacing of it some work that would otherwise secure an article having an importance measured by [the value to him of the last unit that he produces]. As it is of no more real consequence to the man to keep one of these articles than it is to keep any other, [the value to him of the last unit that he produces] measures the subjective value of each of them. . . . Bread and the other necessaries of life are absolutely more important than jewelry and other luxuries; but in effective utility the complements are all on a par, since, if any one of them were destroyed, the result would be to make the community go without the last.John Bates Clark, The Distribution of Wealth: A Theory of Wages, Interest, and Profits 385, 388 (1914).
Clark’s argument is that if any one of the inframarginal units (Clark calls this bread, or another necessity, to illustrate that it is valued more highly than the marginal unit) is destroyed, the only actual unit that disappears from production is the marginal unit (Clark calls the marginal unit a luxury good to illustrate the fact that the consumer values it less than inframarginal units), because one unit is subtracted from output. Because consumers lose the value of the marginal unit when the inframarginal unit is destroyed, it follows, according to Clark, that the true value of the inframarginal unit is actually the value to the consumers of the marginal unit.
That allows Clark to treat all inframarginal units as having no value to the consumer that is separate from the value of the marginal unit, which is to say that it allows him to ignore entirely the value of inframarginal units and to treat the value to the consumer of the marginal unit as the entire value of production. It then follows that because the competitive price equals both the value of the marginal unit to the consumer and the marginal cost of producing that additional unit, there is in fact no surplus generated by any transaction, and the consumer pays a price exactly equal to the value the consumer receives from production and the producer is paid a price exactly equal to the producer’s cost of production. Thus the problem of distributive justice is not so much resolved in a fair way by competitive markets as it is eliminated entirely, because under competition there are, according to Clark, no gains from trade at all, just a buyer and a seller who both subsist on a knife’s edge, buying and selling at a competitive price that leaves both just as well off as each would be had neither entered the market at all.
But is Clark right to argue that inframarginal units have no real value to consumers, because their disappearance would, individually, deprive the consumer only of the marginal unit?
Of course not. The enjoyment you get from eating your first scoop of ice cream is real, whether you eat a second scoop or not. And the enjoyment you get from eating your first scoop of ice cream really is greater than the enjoyment you get from eating your second scoop of ice cream, notwithstanding the fact that if your first scoop is somehow clawed back, you won’t be able to eat that second scoop and get the lesser enjoyment from it. Indeed, once that first scoop is clawed back, your second scoop becomes your first scoop, and your enjoyment of it goes up. That’s why monopolies restrict output. They know consumers place a higher value on the first few units they consume, allowing monopolies to charge them higher prices.
Clark’s argument implies that the more you eat, the less valuable your meal is to you, because the less valuable is your last bite. That’s highly counterintuitive. Few would prefer a cracker for dinner to a four course meal, even if the last bite of that four course meal is worth less to them than would the first bite of that cracker. So why did Clark come up with such a view?
It seems to me that the strangeness of Clark’s theory is a measure of the level of disappointment felt by those who believed in the justice of competitive markets at the implication of the marginalism that the distribution of wealth in competitive markets is arbitrary. True, marginalism validated the Adam Smithian faith in the efficiency of competitive markets. But what had always been at stake in economic debates was the morality of the market, and this marginalism could not prove.
Clark’s failure to prove the distributive justice of the competitive market is a warning to those today who would promote greater antitrust enforcement and competition more generally as a solution to economic inequality. Indeed, the progressives of Clark’s own day, who were profoundly concerned about economic inequality, tended to reject antitrust and competition as solutions.