Ordinarily, price and cost are close or identical, and people don't buy something whose price is greater than their benefit, so situations like my restaurant example don't arise. Some other restaurant would charge only $30 for that same meal, and the diner, being rational, will go there instead. Or, the diner, being rational, will see that the price of $50 is greater than his benefit of $40 and not buy the meal. If the price equals the cost of $30, and the diner is rational, the market outcome is efficient: the transaction will occur if the diner's benefit is greater than the cost, and not occur otherwise. This is the idea of the Invisible Hand's benificience.

Where welfare economics gets interesting is where there is market failure of some kind, and the Invisible Hand fails. This need not lead to inefficiency. In my original example, the Invisible Hand failed for two reasons-- (1) the restaurant charged a price above cost, and (2) the diner bought a meal whose price was above his benefit. As a result of there being both failures, the efficient result was attained anyway: the meal was bought. If the cost had been $45, however, then even if price equalled cost, the diner's irrationality would have made him buy the meal, with the result that society would be spending $45 in resources for a good worth $40, an inefficient outcome. Or, if the cost were $30 and the price was $50, but the diner was rational and refused to buy it, the result would also be inefficient.

Consider, now, an ethical person, rational but trying to decide what to do based on social welfare rather than whether his personal benefit is greater than the cost of an item. In the example, this person should pay $50 for the meal that gives him a benefit of $40. He loses $10 himself, but the seller has a surplus of $20, which is greater. If the surplus of the seller has equal moral value (that is, if we don't hold it against the seller that he charges so much), then his profit is part of social surplus.

This idea has big implications. I am now thinking of whether to send my daughter to the Lighthouse Academy, a private school, for $2,500/year instead of to the public school, Rogers, for free. But the social cost of the Lighthouse Academy is probably about $2500/year (they subsidize poor families, and probably get some contributions too), whereas the social cost of the public school is perhaps $4,500. Thus, looking at social welfare would tend to make me send Amelia to Lighthouse, whereas private interest tends towards Rogers. (Of course there are lots of other complications, e.g., the quality of education, the benefits to Amelia, the benefits Amelia would give to other students, and so forth.)

Another implication is in how we regard the spending of rich people. A common argument for taxing the rich more heavily is that their marginal utility of income is lower-- more simply, they don't need the money. If a rich person spends $10,000 on an Impressionist painting, he would not get as much utility as if a poor person spent the $10,000 on a new roof for his house. But look not at prices, but costs. The cost of the Impressionist painting is much lower-- it is the time of the painter, who was not famous at the time and would not have gotten much in alternative wages. The price is $10,000 now only because of scarcity value, and whoever bought it from the painter and sells it to the rich person is making a gigantic profit. So the rich person's expenditure is not really a social cost. If the social cost of the spending is $500, then the rich person's utility from the $500 plus the utility that the seller of the painting gets from the $9500 profit is a lot closer to the utility from the poor person spending the $10,000 on a house roof.

Rich people, in fact, tend to spend the big money on goods whose price far exceed their costs. What do you do if you are a millionaire? You buy art, other collectibles, and real estate-- all of whose prices have a high "rent" component, a price greatly in excess of social cost. You also buy caviar, fancy cars, and so forth, which have prices closer to their social costs, but it's hard to actually consume a million dollars in a year in social cost. Instead, rich people buy things that they don't consume-- they only hold onto for some time-- and whose prices exceed their costs.

This reminds me of a paper I heard at the American Law and Economics Association conference by Prof. Lior Strahilevitz of the University of Chicago Law School, "The Right to Destroy". We do worry when rich people destroy rare paintings or lock up the value of real estate permanently. I think it is because then real costs are imposed.