INTRODUCTION

The objectives of the paper

Economists are often asked to give policy advice in situations where, it is claimed, prices give distorted or misleading signals. And many of them are fond of suggesting that governments should leave more to the market so that private agents can respond effectively to price incentives. While these positions are not necessarily contradictory, their juxtaposition should lead us to ask some questions. What do we mean by misleading signals? Can we define satisfactorily an index of scarcity or value which is not misleading? How do we identify the social opportunity cost or shadow price of a commodity? How do these shadow prices compare with market prices and under what circumstances will they coincide? Should governments leave decisions to the market when prices give impaired signals? How can the government improve price, tax, or regulatory incentives? How can concern with income distribution be integrated systematically with measures to improve efficiency? Generally, how can shadow prices and market prices be combined in the understanding and implementation of the reform of government policies?

The purpose of this paper is to suggest a framework for the analysis of these issues and to provide the practitioner with a structured and productive way of thinking about the problems of how market distortions should influence proposals for reform. In so doing we attempt to provide help in identifying the empirical questions that should be raised and the judgements that need to be made before deciding on a particular line of policy.