Market and Nonmarket Allocation Research Paper

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While markets are pervasive forms of social organization, there are many goods and services which we do not distribute through markets. For example, we allow people to buy, sell, and trade cars and shirts, but market exchanges of votes, sex, and kidneys are banned. What reasons can be given in favor of using and refraining from using markets? Many debates in the twentieth century have centered around this question. In this research paper, the myriad of reasons to use or refrain from using markets—including efficiency, distributive justice, and the effects of markets on democratic institutions, people, and culture—are considered. This research paper also examines ways of enriching the list of distributive alternatives beyond the two poles of centralized plan and market.

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1. What is a Market?

Modern economic textbooks treat markets as mechanisms for the production, circulation, and valuation of goods and services. As such, they have three noteworthy features: they are efficient, impersonal, and oriented to individual preference and choice. Let us consider these features in more detail.

Since rational individuals will only exchange goods and services when they have something to gain, markets will be efficient—purging the economy of the less desirable goods and moving the trading parties to preferred positions. Economists refer to this property of markets in terms of ‘Pareto optimality.’ A state of affairs is Pareto optimal when no one can be made better off (i.e., their utility increased) without someone else being made worse off (i.e., their utility decreased). An important result in economics, the so-called ‘fundamental theorem of welfare economics,’ shows that in a world in which everyone could trade everything—including futures, uncertainty, and so on—the allocation of resources would be Pareto optimal. This theorem formalizes the earlier conjectures of Adam Smith and others, that participation in competitive markets would lead rational self-interested individuals to produce, as an unintended consequence of their private actions, collectively good results.

Markets are also impersonal, suitable to regulating the interactions of strangers. They abstract away from particular features of a participant, such as his or her race, religion, or sexual orientation and focus only on his or her money income. The impersonality of market relations means that each individual is indifferent to his or her trading partners at any time. He or she has no precontractual obligations to those he or she trades with, and is free to consider only his or her own interests in pursuing an exchange.

In market exchange, the parties also express their own individual choices, pursuing their own sense of what is good, independent of what the state or others value. Markets are thereby conducive to individual freedom: they accommodate individual preferences without passing judgment upon them. By decentralizing decision making, markets give individuals a significant measure of freedom over their circumstances. Furthermore, one is free to walk away from any exchange—the same deal can be struck elsewhere, as it were. Albert Hirschman (1970) has termed this latter feature the power of ‘exit,’ to distinguish it from the power of ‘voice’ (i.e., speaking up).

1.1 A Contrast

The modern, neoclassical conception of economics, developed in the late nineteenth and early twentieth centuries by Edgeworth, Robbins, and Jevons, treats the market as something obvious and simple. In the standard neoclassical general equilibrium model of a market economy formulated by Leon Walras (1926 1954), commodities are identical, the market is concentrated at a single point in space, individuals have complete information about the exchange commodity, and exchange is instantaneous. There are, accordingly, no costs in enforcing agreements and no important distinctions among kinds of markets.

The neoclassical treatment of markets has produced important mathematical results such as the fundamental theorem, and also allowed for the development of powerful models which can characterize the equilibrium properties of an entire economy. But it depends on viewing markets as economic mechanisms whose operation can be understood in abstraction from the particular kinds of goods being exchanged and the relationships between the participants. In the neoclassical conception of markets, it does not matter whether what is being traded is oranges, sexual services, or credit—the nature of market exchange is seen as the same in each case. The participants are considered interchangeable and, given the opportunities each has for exit, no party can exercise significant power over another. In Paul Samuelson’s words, ‘in a perfectly competitive market, it does not matter who hires whom: so let labor hire ‘‘capital.’’’(Samuelson 1957, p. 894) The result is that the market is viewed as a private realm, whose smooth operation leaves no room for political intervention: intervention is justified only when markets in some goods fail to be established or are inefficient.

By contrast, the classical economists–among them Adam Smith, David Ricardo, and Karl Marx—offered distinct theories of the operation of markets in different domains and focused on the opposing interests of the three main social classes—landlords, capitalists, and workers—who came together to trade and between whom the social wealth was to be distributed. Not only were markets viewed as political, in the sense that they depended on legal property rights, but it was also recognized that their functioning in certain realms inevitably raised questions relevant to the structure of public life. For example, the classical economists noted that the market between buyers and sellers of goods such as oranges differs importantly from the market between buyers and sellers of human labor power. This is because the latter kind of market involves a good which has the unusual status of being embodied in a human being. While we do not have to worry about the noneconomic effects of a market on fruits, we do need to worry about whether a particular market in human labor power produces passivity, alienation, greed, or indifference to others.

The classical economists saw the marketplace as a political and cultural as well as an economic institution, where differing interests wielded power and where some types of exchanges had constitutive effects on their participants. Adam Smith (1776 1937) worried not only about the tendency of the owners of capital to collude and thus block market competition, but also about the effects of a fragmented and monotonous division of labor on the ability of workers to participate in political life.

2. Criteria for Assessing the Use of Markets

The most famous modern debates about the legitimacy of market allocation versus its alternatives have focused on its efficiency. Consider, for example, the debate between socialist economist Oskar Lange and conservative economist Friedrich Hayek which took place during the 1930s, when the Soviet experiment was underway. Lange and Hayek debated whether a noncapitalist economy with few market structures could experience economic growth. Lange argued that an ideal planned economy could allocate resources in a more optimal manner than a perfectly competitive market economy. In rebuttal, Hayek pointed out that planned economies have a tendency towards bureaucratic sclerosis, a lack of accountability and high information processing costs.

Each side raised important considerations. But from many perspectives their debate about markets can be criticized as narrow and conceptually impoverished. The debate not only tended to operate as if there were just two choices—command centralized planning and the neoclassical rendition of the market as perfectly efficient—but also posed the issue about market or nonmarket choice solely in terms of efficiency.

If we see the market as a complex heterogeneous institution, which brings people into different kinds of relations with each other for different exchanges, then we can also see why the use of markets can raise other concerns besides efficiency. From this broader perspective, not only efficiency but also the effects of the market on the political structure of power and on human development are relevant to determining when and where markets should allocate goods and services and where other institutions should be used.

2.1 Efficiency

Through the use of prices, markets indicate what millions of goods and services are worth to sellers and buyers. They thereby function to apportion resources efficiently: they signal to sellers what to produce, to consumers what to buy, and to capitalists where to invest. The continual adjustments of supply and demand, registered in changing prices, allow markets to ‘clear’ inventory. When inventory is cleared, there is no excess demand or supply: supply equals demand at some price. The efficiency benefits that markets produce constitutes an important prima facie case for their inclusion in an economy. Indeed, we know of no mechanism for inducing innovation on an economywide basis except market competition.

In certain circumstances, however, markets themselves fail to be efficient. While in the neoclassical textbook model of market exchange transaction costs are taken to be zero, and each participant to have perfect information and act solely on the basis of his or her rational self-interest, it is well recognized that these assumptions do not always hold in reality. Thus, the standard theorems connecting markets and efficiency are coupled with a theory identifying ‘market failures,’ circumstances in which the utility-enhancing effects of markets are either inoperable or eroded. For example, markets fail when and where certain effects of an exchange—which economists call ‘externalities’—are not fully absorbed by the exchanging parties and are passed on to third parties. In some circumstances, these external costs constitute public bads: the defacement of the landscape, pollution, and urban decay are notable examples. Markets also fail where there are natural monopolies, or technologies which give rise to economies of scale, thus making only monopolistic or oligopolistic firms viable.

Recent work within mainstream economics has shown that market failure may be more widespread than previously supposed. This work emphasizes the ubiquity of imperfect and asymmetric information held by the exchanging parties (Akerlof 1970) as well as the fact that in many exchanges the parties cannot costlessly control one another’s behavior. (Consider the costs of supervision that employers pay to make sure that their workers are actually working.) Economic models now take into account the incentives agents have to manipulate information and outcomes in order to press their own advantages. Thus, agents may act as if they were willing to pay less for goods and services than they really are, or threaten to withdraw from a trade entirely. It is now recognized that people can act in ways that prevent markets from clearing even in competitive equilibrium—there will be persistent excess supply or excess demand. This is because if one party wants power over the other, he or she can achieve this by giving the other something to lose, so that it now costs something to ‘exit.’ Thus, because not all prospective borrowers can find loans and not all those who seek jobs can find them, those who do have a strong interest in complying with the banks or owners (Stiglitz and Weiss 1981). The power that banks thus acquire over their creditors and owners acquire over their workers gives these markets a political character. One might say that this recent work emphasizing strategic action, incomplete information, and transaction costs gives mathematical precision to some of the earlier insights of the classical economists.

Various solutions to market failure have been proposed including political intervention in the marketplace, expansion in the number of markets (e.g., allowing externalities themselves to be priced by the market) and the use of nonmarket alternatives such as bargaining and negotiation. The point of such solutions is to restore efficiency.

In thinking about the ways that markets contribute to efficiency, we should note that the actual efficiency outcomes of the market depend on the initial distribution of endowments and assets. This initial distribution is not itself part of the definition of Pareto optimality. A state of the world can be Pareto optimal, even if its original distribution was based on theft and fraud or was otherwise unfair. In order to justify market outcomes, or to use Pareto optimality normatively, the theory of market efficiency needs to be supplemented with a theory of distributive justice. Some theories of distributive justice focus on the legitimacy of the initial distribution of assets while others focus on the legitimacy of the distributive inequalities that the market produces.

A related point is that efficiency interpreted as Pareto optimality has only modest moral content. This is true for several reasons. First, Pareto optimality deals exclusively with efficiency and pays no attention to distribution. A Pareto optimal state can thus be a state of social misery for some. Simply consider the case in which the utility of the downtrodden cannot be raised without lowering the utility of the millionaires. Second, the Pareto criteria dispenses with interpersonal comparisons, so that we cannot compare the contribution a meal makes to the poor man’s utility with that it makes to a millionaire’s.

2.2 Freedom

Market allocation is often defended in terms of freedom. Proponents cite a range of important effects which markets have on an individual’s ability to develop and exercise the capacity for liberal freedom. Each of these effects, they argue, depends on leaving the market domain largely cordoned off from political interference. Markets (a) present agents with the opportunity to choose between a large array of alternatives, (b) provide incentives for agents to anticipate the results of their choices and thus foster instrumental rationality, (c) decentralize decision making, giving to an agent alone the power to buy and sell things and services without requiring him or her to ask anyone else’s permission or take anyone else’s values into account, (d) place limits on the viability of coercive social relationships by providing (relatively) unimpeded avenues for exit, (e) decentralize information, (f) (may) enhance an individual’s sense of responibility for his or her choices and preferences, (g) allow people to practice and try out various alternatives, (h) create the material wealth which is a precondition for the possibility of having decent alternatives, and (i) allow liberal individuals to cooperate without having to agree on a large range of questions of value (Friedman 1962, Nozick 1974).

Liberal theories which assign substantial weight to individual freedom thus allot a central role for market allocation, pointing to the market realm as a place where the capacity for individual choice—indeed, where the liberal individual—is developed. As liberal theorists are likely to emphasize, respect for markets in goods and services can be an important way of respecting individual (and divergent) conceptions of value. In a market system, there is no preordained pattern of value to which individuals must conform and exchange gives to individuals the freedom to pursue distinct aims. In fact, the market leaves people free not to choose to sell or buy a particular good on the market.

The liberal theory of freedom is essentially (although not entirely) a negative one, emphasizing the space markets provide to individuals to pursue their private ends free from external intrusions by the state or other people. This liberal theory linking freedom and markets has been criticized for not attending to the preconditions for its own realization. These preconditions include the existence of some realms which are protected from the market. For example, most liberals recognize that it is incompatible with liberal freedom to allow a person to sell himor herself into slavery; free people require rights to consultation, selfjudgment and control over the conditions in which they act. But many liberals fail to see that freedom also has implications for other kinds of contracts (e.g., bans on desperate exchanges such as those involved in kidney and baby sales). Some theorists have argued that the securing of liberal freedoms requires the guaranteed provision of a minimal level of basic goods such as healthcare, food, and housing and thus requires the regulation of markets.

2.3 Human Flourishing

Market allocation has often been defended on the grounds that markets, by satisfying people’s preferences, contribute directly to human happiness and flourishing. In addition, by stimulating economic growth, markets have the potential to eradicate the poverty and hardship which is everywhere the enemy of a decent quality of life. Certainly, the market makes important contributions to the satisfaction of human wants. But, in considering the effectiveness of the market in maximizing overall human well being, several factors need to be taken into account. First, satisfaction of the subjective preferences of an individual agent may not provide that agent with well being. A lot depends on the content and nature of his or her preferences. Agents may have preferences for things that do not contribute to their overall good, preferences which are mere accommodations to their circumstances, preferences they themselves wish they did not have, preferences based on false information, and preferences which are instilled in them by the market. In some such examples, the case for regulation can be made on paternalistic grounds, excluding exchanges born of desperation, (such as selling oneself into slavery), lack of information, and imprudence.

Second, the market recognizes only those preferences which can be backed up by an ability to pay. The poor man’s preferences for a good meal are invisible. Indeed, the notion of ‘preference’ itself does not distinguish between kinds of preferences, only degrees of strength. Thus, the market cannot distinguish between urgent human needs (the poor man’s desire for nourishment) and mere whims (the rich man’s desire for a fine burgundy). Third, there are important sources of satisfaction that do not go through the market: public goods that, by their nature, do not go through the market and interpersonal relations which may be spoiled if they become part of the market’s transactional network. So care must be taken to avoid ignoring those preferences that are not expressed on the market.

Some critics have claimed that, even if this care is taken, the use of markets promotes an inferior form of human flourishing. This criticism has a wide interpretation and a narrow interpretation. On the wide interpretation, markets everywhere shape and socialize people in the wrong way. They are taken to do this by promoting selfish behavior, making people more materialistic, and dulling people to important distinctions of value to which they should be responsive.

This worry about markets is sometimes posed in terms of the metaphor of infection—that market norms and relations will spill over and contaminate nonmarket realms such as friendship and love. Thus, it has been alleged that markets erode our appreciation of the true value of other people, since they lead us to think of goods and people as exchangeable items. This wide interpretation of the market’s negative effects on human flourishing has only weak social scientific support. There is little evidence that people are more materialistic in market societies than they were in peasant economies, that they devalue love and friendship, or that they are now less likely to engage in moral behavior than in the past (Lane 1991).

A narrower interpretation of this humanistic criticism is that some (but not all) markets have bad feedback effects on particular human behaviors. Studies have shown, for example, that economics and business students (who presumably are more likely to govern their behavior by the axioms of neoclassical economics than are literature or sociology students) are uniquely uncooperative in solving collective action problems (Marwell and Ames 1981).

One important negative feedback effect was identified by Richard Titmuss (1971). Titmuss claimed that allowing blood to be sold and bought as a commodity would have two negative effects: (a) fewer people would give blood for altruistic reasons and (b) the quality of blood would thereby be lower. Titmuss’ main thesis concerned the first effect: he argued that over time, a blood market would drive out altruistic blood donation by turning the ‘gift of life’ into the monetary equivalent of 50 dollars. People would become less willing to give blood freely as market distribution became more prevalent, for their gift loses its benevolent meaning. (Blood quality would be lower since altruistic donors have no incentive to lie about the quality of their blood, while commercial donors clearly do.)

Titmuss aimed to show that markets have broader incentive effects than economists have supposed. His account also challenged the liberal theory of freedom. In his view, allowing a market in blood does not merely add one additional choice to the prospective donor (who can now sell as well as give blood), there is also a feedback mechanism that diminishes the likelihood of donors giving blood for free. If this is so, then sometimes market regulation—including prohibition of certain exchanges—may shore up liberal freedom by allowing us to get the choice that we most want. (Consider the role of minimum wage laws and prohibitions on vote-selling from shrinking people’s opportunity sets over time.)

Another possible negative feedback on motivation was the concern of diverse thinkers such as Adam Smith, Karl Marx and John Stuart Mill, who each worried that labor markets which rendered workers as mere appendages to machines would cripple their capacity for independence and political participation. Each thinker noticed that labor market exchanges had a constitutive effect on the parties to the exchange: workers who engaged in servile, menial, and degrading work were likely to be servile citizens.

Where markets have significant feedback effects on human motivation, there is a strong case for social regulation. It is circular to justify markets on the grounds that they maximally satisfy individual preferences in cases where those preferences are themselves shaped by the market. At the very least, recognition of the endogenous nature of some preferences leaves the question of institutional design open since there may be other mechanisms that generate and satisfy more preferences.

2.4 The Nature of the Goods Exchanged

Liberals have traditionally argued that many of the problems that unregulated markets cause with respect to the values of efficiency, justice, freedom, and wellbeing can be attenuated through state intervention. We can redistribute income and regulate consumption through taxation, publicly provide for social goods such as schools and roads, and establish a minimum level of healthcare for all citizens. Markets can be supported by other social institutions that encourage values such as honesty, reciprocity, and trust.

There is a different criticism of the market that cannot be addressed through market regulation but requires that the use of the market be blocked. This criticism focuses not on the negative consequences of market exchanges but on the ways that markets undermine the intrinsic nature of certain goods. The theorists who make this criticism reject the use of markets in certain domains and for certain goods categorically.

Markets are often taken to be neutral means of exchange. By this proponents mean that the market does not distinguish between my ethical valuation of a good and yours. I may value my Bible infinitely while you assign it a dollar price, but the market is compatible with both of our understandings of this good. The market responds only to effective demand, not to the reasons people have for wanting things. When the market puts a price on a thing, it leaves the ways that people value it untouched.

In reality, this view of market neutrality is overstated. Some goods are changed or destroyed by being put up for sale. The most obvious examples of this phenomenon are love or friendship. A person who thought that they could buy my friendship would simply not know what it means to be a friend. A proposal to buy love, prizes, honors, friends, or divine grace is conceptually incoherent: it is the nature of these things that they cannot be bought.

Various arguments have been given to show that a wide range of goods are not properly conceived of as market commodities. Some of these arguments depend on the idea that certain goods are degraded when sold, or that some sales are inherently alienating to, or exploitative of, the seller. Items that have been proposed to be withheld from the market in order to preserve their nature include sex, reproductive labor, adoption, military service, healthcare, and political goods such as votes and influence.

Consider sex and reproductive labor. Some feminists have argued that markets are inappropriate for exchanging goods that place people in personal relations with each other. They argue that when sexual relations are governed by the market, such as in prostitution, not only is an inferior good produced since commercial sex is not the same as sex given out of love, but also that the dignity and freedom of the prostitute is compromised. Because practices such as prostitution are alleged to allow women’s bodies to be controlled by others, these arguments conclude that women’s freedom requires that their sexual and reproductive capacities remain market-inalienable (Radin 1996).

Given the relatively poor economic opportunities open to many women, one may doubt whether paid pregnancy or prostitution is comparatively worse for women’s freedom than the alternatives. For example, is prostitution more constraining than low-paid, monotonous assembly-line work? Does commercial surrogacy really place more extensive control over a woman’s body than other acceptable labor contracts such as those given to professional athletes? To answer these questions may be more a matter of looking at the empirical consequences of markets in sex and reproduction, and the history of women’s roles in the economy and the family, than of examining the intrinsic nature of these goods.

2.5 Democracy

A special case is often made for regulating or banning markets so as to ensure that democratic institutions are supported. This case has several components: (a) a theory of those political goods which must be provided to everyone equally in a democracy—goods such as votes, political rights, and liberties; (b) a theory of the economic preconditions of democracy; and (c) a theory of the kind of institutions which foster the development of people likely to support democratic institutions and function effectively in a democratic environment. It is easy to see that democracy is incompatible with property qualifications on the right to vote, slavery, and vote selling. Current debates center around whether democracy requires greater regulation of the political process including public funding of elections and campaigns, whether democracy requires greater regulation of the economy to allow for ‘voice,’ and whether expanding the market to education would enhance or inhibit the development of democratic citizens.

3. Regulation vs. Alternatives

Arguments that purport to show that markets in some good do not promote freedom or happiness or wellbeing or some other value do not directly enable us to conclude that such exchanges should be blocked. Even if markets interfered with or failed to promote certain values, interference with them might be worse overall from the point of view of those same values. Suppose, for example, that the only feasible institutional alternatives to markets all involved significant amounts of coercion. Furthermore, a small amount of economic inefficiency might be better than a whole lot of red tape. Conservatives frequently cite the costs of ‘overregulated’ markets such as rent control and limits on parental choice with respect to education. So, a full assessment of market allocation must take into account the alternatives.

3.1 Other Forms of Market Regulation

In addition to regulating the market through redistribution of the income and wealth it produces, other forms of market regulation have been suggested. These include: restrictions on the transferability of income and wealth, as in ownership requirements which stipulate that owners must be active participants in the community in which their property is located, and restrictions as to what people can do to the things they can sell, as in historical building codes.

3.2 Nonmarket Allocation

There are important alternative mechanisms for distribution that do not rely on a market. In the twentieth century, the most important alternative allocation mechanism has been the government. Government decision has allocated such goods to individuals as citizenship, social security, social infrastructure such as roads, highways, and bridges, and education up to early adulthood.

Many allocative decisions are shaped neither by government nor by the market. These include distribution through gift, lottery, merit, the intrafamily regulation of work and distribution, and other principles such as seniority and need. Consider a few cases. In the USA, the lottery has been used to allocate resources literally bearing on issues of life and death. Military service, especially during wartime, has often been selected for by lottery; the alternative has been to allow people to volunteer. College admission, election to professional associations, and the award of prizes have been governed neither by market norms nor by state decree but by selective principles of merit and desert. Need has been central in allocating organs for transplantation. In each of these cases, one can compare the allocation achieved with that which would have been achieved through a market, in terms of the broad list of criteria specified above.


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