Allocation

The accepted purview of economics is the allocation of scarce resources. Allocation comprises production and exchange, reflecting a fundamental division between processes that transform commodities (i.e., production) and those that transfer control (i.e., exchange). In general, optimal allocation ensures that scarce resources are driven to their best use.

For both production and consumption, exchange is essential to the efficient use of resources. It allows decentralization and specialization in production; as to consumption, agents with diverse endowments or preferences (tastes) need exchange to obtain maximal benefits, given their resources. If the preferences of two agents differ (formally, if agents have different rates of substitution among the commodities concerned), then there exists a trade benefitting both. Such trades of private goods take place on markets.

The advantages of barter extend widely, e.g. to trade among nations and among legislators ("vote trading"), but it suffices here to emphasize markets with enforceable contracts for trading private property unaffected by externalities. In such markets, voluntary exchange involves trading bundles of commodities or obligations to the mutual advantage of all parties to the transaction.

See also: externalities, markets, preferences

Literature: Reiter (1987)

Entry by: Joachim Winter

June 17, 1999
Direct questions and comments to: Glossary master