Internalization and value capture

When you first learned about the market price mechanism, you understood that it was a method to “internalize” the social consequences of your actions into private consequences so you would always do the socially optimal thing. This is, by the way, an absolutely ingenious fact – that a free society, in some mathematically elegant way, actually leads to “socially optimal” (from some perspective) solutions.

But then the thought occurs to you – how can the reward for your actions (the price of a good you’re selling) be equal to the value you created? (Why would you be allowed to keep all the value?) 

Indeed, it is not – from the perspective of the buyer, the price he’s buying the good for represents the cost that his consumption creates to everyone else, i.e. the opportunity cost of that resource not being allocated to the next best use of that resource. If you’re selling 5kg of steel to a buyer, then the amount you earn is not the value of the 5kg steel to the buyer – the amount you earn is the marginal benefit of the last infinitesimal bit of steel, multiplied by 5kg.