I think, economists generally argue that the market is the most promising tool we have at hand to allocate the right price to traded goods. Some argue, only a free market is likely to minimize inefficiencies and, thus, get it right while others argue, without regulation we are all doomed towards a global race to the bottom. If we agree that getting the price right is at all a desirable condition, I argue, whatever market is your favorite, a necessary condition for getting it right is perfect information. Of course, perfect information is utopic as much as a truly free market, limits one never really reaches. However, I think, 0.8 close might be more worthwhile than 0.2. So, why do I argue perfect information is a necessary condition for any market to assign the right price to traded goods?
Assume a new product that is expected to hit the market within weeks and contains a chemical compound for which long term health and environmental effects are unknown. The seller does some research to figure out a price – which, of course, reflects her own self-interest – and consumers express their opinions by voting with their wallets. Over time, the market will settle for the right price or the product will disappear. Sounds straightforward, at least on paper.
I think, there is at least one problem: The lack of information about the health and environmental effects of the new chemical compound. Being the effects unknown, I believe, the price the market will settle on is likely to be wrong. Thus, if we care about getting it right, I think, we must see this as a market failure.
Now, if it turns out that the new chemical compound has no negative health or environmental effects, we might argue that the price was right – at least w.r.t. those two dimensions. If, however, if turns out that the introduction of the chemical compound does indeed negatively affect, e.g., the environment, then, I argue, the price was not right.
History is plentiful with examples. A past example: The introduction of CFC in refrigerators. How much would a CFC refrigerator have cost if the price had accounted for the environmental damage (Ozone depletion)? A present example: Cigarettes. How much would a cigarette cost if we internalize the costs of its adverse health effects? A future example: What would the price of a cell phone today be if tomorrow they are banned from public places because of better knowledge on (possible) adverse health effects of wireless communication technology?
On a side note, I believe health and environmental effects are not the only critical dimensions.