Allocation of Inherently Scarce Resources

The discipline of economics is devoted to the allocation of scarce resources. Typically, in a capitalist society, the process of distribution is left to the open markets. However, the government may sometimes determine that a good is inherently scarce, in which case, the distribution system might be different.

Inherently scare resources can range from broadcast frequencies to law school admission to organ donations to the ozone layer. These resources are usually very valuable because of their nature, and can be distributed or allocated in a number of ways. Unfortunately, allocating inherently scarce resources is often not as easy as allocating more abundant resources. Any distribution system should have the goal of allocating the resources like a true open market, as “efficiently” and “democratically” as possible. But, in the case of inherently scarce resources, these goals are difficult to meet. And with all methods, there is a question of aftermarket distribution.

The traditional example of a technological inherently scarce resource is broadcast frequencies. In the past, the number of frequencies available was actually limited in an absolute sense because the overuse of the spectrum would render all frequencies useless. Now, although the spectrum has not changed, there is vastly greater opportunity to communicate to others through other technologies, such as the Internet or Cable television with its almost unlimited number of available channels.

However, resources that in the past were considered to be abundant public goods are now known to be scarce. For example, fresh air, clean water, the ozone layer, and rain forests could all be considered the inherently scarce resources of this generation. Scarce resources are those for which there demand exceeds a limited supply. While it is difficult to foresee such a situation arising for those natural resources, it would be disastrous if it did. In terms of technology, bandwidth could be considered a scarce resource, as there may be a limited amount of bandwidth available on a given network. If that is the case, mechanisms of allocating portions of the bandwidth might be needed.

The most plausible methods of distribution are a lottery, municipal giveaway, or an auction. There are problems with each system, but the auction is probably the most efficient for distribution.

In a municipal or government operation, there is less worry about efficiency, less transparency, and less incentive to keep costs down. In a lottery, who gets to participate? The ones who would use the resource most efficiently have the same chance of getting the resource as those who would be least efficient. The good thing is that everyone has a chance (there is fairness), but this method is very inefficient.

If one views the sum a potential user would bid as a measure of the value to the bidder of the productive use of the resource, then it follows that an auction would allocate the scarce resources to the most valuable or productive uses. However, efficiency can be hurt because someone who could pay more for the right to use the resource may not operate the most efficiently. For example, a monopolist would be willing to pay a higher price. The problem with the auction or fee is that you are auctioning off the right to be a player in a limited environment. But this extra profit opportunity is almost unavoidable because if there was no auction or fee, then the end result would be the problem the system was trying to avoid in the first place. For example, if taxi medallions were unlimited, then there would be congestion, which is the whole reason they were supposed to be regulated in the first place.

The more valuable the thing that is being given away, and the clearer it is that it will be profitable, the more the bidders begin to resemble one another.

The problem with allocation is that it is nearly impossible to allocate an inherently scarce resource both efficiently and democratically. For society to adopt any distribution system, it would essentially be making a political choice. According to the Arrow Theorem, no political choice can be both consistently efficient and democratic. This problem comes from the fact that it is nearly impossible to predict what is in the public’s interest without being arbitrary.

Bibliography

Harrison, Morgan, and Verkuil, Regulation and Deregulation, (West Publishing: 1997).

I think you need to more clearly define what you mean by an inherently scarce resource. When you say that scarce resources are those for which demand exceeds limited supply, do you mean resources where the supply is truly inelastic, because there's a finite amount of that resource in the environment? Or are you describing all resources for which market supply is currently smaller than demand as inherently scarce?

If the former is true, then it seems your essay poses a dilemma between efficient and democratic means of distribution that is purely hypothetical. Network bandwidth--be it in any private network or the internet--is not inherently scarce. More cable can always be laid, and technology is increasing the amount of information that can be transmitted across existing copper, fiber and wireless frequencies every year. There is no real inelasticity of supply here.

-- AndreiVoinigescu - 20 Dec 2008