We don't know how much something is worth to us and that's making market economies inefficient

Summary

• The following issues seem to be making market economies inefficient in ways that are hard to quantify:
  • It’s difficult (impossible?) for people to quantify how much a good or a service is really worth to them.
  • People’s willingness to pay is anchored to the market price and the social norms.

I like stuff, but I don’t know how to quantify that

I like avocados and sea urchin, two foods that share a few similarities.

They go well with soy sauce, wasabi, and white rice. They both have rich tastes and creamy textures. They can also be hit or miss – sometimes they’d taste less fresh or more bitter than expected.

On the other hand, I’d say the greatest difference between the two is their prices. The avocado and sea urchin that I had most recently cost around $0.50 and $20 per 100 grams, respectively. That’s a 40 times difference! Do I enjoy sea urchin 40 times more than I enjoy avocados? Probably not!

How many more times do I enjoy it, then? I don’t know, and this is a problem I see not just with my purchasing decisions at supermarkets but also with market economics as a whole. We assume that people know the dollar amount that a good or a service would be worth to them. This assumption, combined with supply-side factors, determine the market prices of goods and services that supposedly allow for an efficient allocation of resources to maximize the overall wellbeing of a society.

That was a gross oversimplification but I think the point still stands: prices that are determined by our willingness to pay are suboptimal, since our willingness to pay is not perfectly correlated to the value we derive from the purchased goods and services.

My willingness to pay is anchored to the prices I’ve seen before

If it’s not just the values they provide, then what other factors affect my willingness to pay? One factor that I know to be affecting my purchasing decisions much more than it should is how the current price compares to what I expected the price to be, which often is what I remember the market price to be.

For instance, if I see an avocado and a sea urchin at $1 and $10 respectively, when I remember them to have been $0.50 and $20 the week before, then I’d be much more eager to buy the sea urchin than the avocado, even though the sea urchin might not bring me 10 times as much joy as the avocado and I’d be better off buying the latter!

This is likely due to the anchoring effect, where my willingness to pay is pulled towards the prices I expect to see, and when the current price is more expensive / cheaper than what I expected, it feels more / less than my willingness to pay, respectively.

Market economies are made inefficient as a result

This disconnect between our willingness to pay and the values the goods and services provide could a significant issue with market economics. If in fact there is a big disconnect between the two, then that’d lead a market economy to allocate its resources to produce more of the things that don’t make people all that much happier, or produce less of the things that actually would.

This seems like an issue that is fundamental but yet hard to solve. If we can’t quantify the value that goods and services provide us, then we don’t know how much of a problem it is, or whether certain interventions to a free market economy can alleviate it. Is this an unsolvable problem?