Income inequality and markets

January 2014

Epistemic status: needs empirical support.

When people talk about starting businesses that provide social value, one point that often comes up is that you can’t trust market incentives, because they’re skewed by income inequality. Since rich people are able to pay more for things they enjoy, it’s disproportionately rewarding (relative to its social value) to make products for rich people. For example, perhaps Apple could make lower-quality computers and sell them at a lower price point; this would create more social value (because it would only slightly reduce the value that people derive from Apple computers, and more people would be able to purchase them), but it would be less profitable for Apple (because they couldn’t get away with as large of a margin).

Prima facie it seems strange that rich people should ever actually pay more per unit enjoyment (“hedon”). For instance, suppose that Casey is rich and is willing to pay $20/hedon, while Dana is poor and is only willing to pay $10/hedon. Why should Casey ever pay more than $10/hedon for a product? For this to happen, ey would have to consume all possible goods at $10/hedon and hit diminishing marginal returns. In a society with as many goods as ours, this seems completely implausible.

The answer is that it’s not just hedons that matter. Casey is only capable of consuming a certain amount of goods, irrespective of their hedonic content. As such, what matters to Casey isn’t just hedons but hedonic density. An Apple computer provides more hedons per amount interacting with it than its inferior substitutes. Income inequality skews markets towards greater hedonic density than would be socially optimal.

Unfortunately, even skewed markets provide a much better incentive structure than trying really hard to theorize about what works. So we should probably keep them around if we want to make sure that we’re actually creating social value. Given this, how can this risk of distorted markets be avoided or limited? I can think of a couple ways that might work:

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