Improving pricing efficiency

This definition in turn helps determine opportunity costs. The opportunity cost of any good or service is the value of forgone alternatives. If the alternative to using a good were to export it, for example, the opportunity cost would be measured by the border price of the good and the resulting foreign exchange that could have been used to purchase some other import or to replace some other export. The scarcity value measures what the good is worth to the economy-calculated, for example, by the value of the extra exports the good enables to be produced. If the economy is producing efficiently, scarcity values must be equal to opportunity costs, and their common value is the efficiency price-which, for imports and exports, will then be identical to the border price. For non-traded goods, efficiency prices can be measured by the opportunity cost of their production when the alternative would be to produce traded goods, or by their scarcity value in displacing traded goods.

An economy is efficient, as opposed to just production efficient, if it is impossible to make anyone better off without making someone else worse off. In addition to producing efficiently, the final consumers must have exhausted all possibilities of mutually beneficial exchange. This in turn requires that they all face the same market prices, and that these are equal to efficiency prices. However, an economy may be efficient and yet produce a distribution of income and wealth that is deemed unacceptable. The government may then impose taxes and subsidies or intervene in other ways to improve the distribution of income and wealth. Such intervention may make consumer prices deviate significantly from efficiency prices. But by preserving production efficiency, the largest possible quantity of goods and services will be made available for distribution among consumers. Hence the concepts of production efficiency and efficiency prices remain important for producer prices (for example, before indirect taxes are added) even when market prices (consumer prices) are distorted.

Shadow prices, also known as accounting prices' are the same as efficiency prices if society is concerned exclusively with efficiency in the sense here defined. Typically, however, societies are interested in other objectives-a more equitable distribution of income, for example-as well as efficiency. In this event, shadow prices are measures of social costs and benefits that reflect concern with these other objectives.

2. Price is not the same thing as cost; this means that price signals will not necessarily warn of any impending problems. The price of raw materials often declines as, for example, giant corporations push external costs off onto consumers or indigenous peoples who have little choice but to accept them. The tropical hardwood used in an expensive home does not include in its price the loss of biodiversity in a tropical forest or the carbon dioxide added to the atmosphere as waste wood decayed or was burned and as fossil fuels were used to cut, transport, and process the wood. Also absent from the price are the costs incurred by tropical-forest peoples when their environments and ways of life are destroyed.