Inefficient Market Pricing: An Illusory Economic Box

Abstract

Abstract Welfare economics typically holds that market outcomes are Pareto efficient only if markets are competitive and average costs are constant or increasing. Otherwise, to attain market efficiency requires some regulatory implementation of a rule to equate price to marginal cost, though the ability of such a pricing rule to accomplish this is tempered by second-best considerations. In contrast to this typical claim, we explain why market prices must be Pareto efficient even in the presence of decreasing average costs. The existence of an analytical box labeled ‘inefficient pricing’ turns out to be an illusion that is generated by the imposition of a theoretical convention of price uniformity that has no basis for existence other than analytical convenience. In short, profit seeking alone is sufficient for Pareto efficiency, for Pareto inefficiency simultaneously means that firms are failing to exploit opportunities for profit, and to embrace such a failure provides a poor basis for economic modeling.