Price helps people make decisions. It helps them prioritize. It helps people assign value and meaning to objects. Efforts to centrally control prices have historically caused more problems than they have solved.
By way of example, let’s keep using the coffee analogy we used yesterday to explain the free exchange of goods and services using a common currency.
A 75-cent a cup of joe has a low cost of entry, and therefore it is accessible by just about anyone.
It would be considered a drink for common people.
However, if there were a great coffee famine in Columbia, the price of coffee might shoot up to $15 per cup, and people would be forced to be more judicious with their consumption of coffee.
Keep in mind that the price of producing the coffee would not increase on lands unaffected by the famine. Their costs are exactly the same, only now they can sell their coffee at a higher price because the global supply would be affected.
Most of us — even those who work at an ad agency — would find a way to live without coffee.
With increased prices, it would be considered a drink for the affluent.
To ease your caffeine addiction, you might substitute sodas, tea, energy drinks — something else — in the place of coffee, but you probably would not have bothered were the price of coffee not so high.
Now, a few things could happen from this point. Probably a number of them would happen at once.
- The price of sodas, tea, and energy drinks may increase due to the elevated demand, especially if supply could not be increased quickly.
- The price of coffee could fall with demand until an equilibrium was met.
- If the famine seems as if it will be sustained, some would invest in coffee growth to cash in on greater margins the crop promises to yield.
The growers outside of Columbia would experience a huge spike in their margins: Their costs would have stayed the same, but they would charge a higher price.
To compensate for this horrible famine and “obvious example” of market failure, typified by the “excess profits” of “big coffee,” government may pass a “coffee stimulus package” or place controls on the price of coffee — or promising hefty fines to anyone who “gouges the customers.”
This line of reasoning is completely bunk.
Were price controls to pass (or if the coffee growers were sufficiently afraid of congressional reprimands for making a profit), people would go on consuming coffee as they normally had, but with the decrease in the global coffee supply, this would cause a coffee shortage, and a lot of people who wanted a cup of coffee and who would have paid for it at full market value would not be able to obtain one.
What about price-gouging?
Say you bought a truckload of (Columbian!) coffee before the famine hit, and you paid $3 per pound. After the famine hit, the value of that coffee significantly increased, even though your costs did not. If you’re going to sell your current supply, you have a choice:
- Sell the stock at a same margins you had been before the famine.
- Sell the stock at a rate that would allow you to buy and sell more.
Choosing option #1 would stave off the Congressional investigations, but option #2 will allow you to earn a living. With option #1, you wouldn’t earn enough to buy much coffee. Option #2 would ensure you had ample supply for people willing to open their eyes to the reality of the shortage before them.
Plus, as we explored yesterday, no one is forced to buy what you have, at your price.
Price helps govern demand so that supply is adequate.
If anyone were selling coffee at the previous levels, the smart business person would buy up his entire stock and resell it at market price. Plus, if your competitor decided to charge above what the market would bear, people would naturally consume less, which would result in less income for your competitor.
In this way, prices regulate themselves.
People have a choice to use their money how they wish in a marketplace of virtually infinite options. They will refuse to buy if the price is too high. And they make these decisions every day, on their own and without government interference.
This does not mean that everyone always makes the best possible choices from the available options, but the choice is theirs, and no one else’s. That is freedom.
(This implies, by the way, that freedom requires a certain level of discernment and wisdom — a topic for another day)
In fact, government interference just restricts companies from compensating for the realities of the marketplace, which makes it harder for them to make a profit, employ people, grow their businesses, and maintain a high level of productivity that is necessary for a growing economy. – Cam Beck
It would be useful to talk about how these principles apply to something specific that’s in the news. You get to decide which. Here are your options.
- The housing market
- The consequences of the XM/Sirius merger
Please cast your vote in the comments section, along with anything else you’d like to talk about.