Here in Argentina we are facing an extremely high
inflation in comparison to the rest of the world. In 2012 the annual rate was (at
least) 25.6%, according to the Congress of this country. You need to understand
this first: In this country, the ultra-interventionist government is so
arbitrary that in 2007 (actually several months before that year) intervened
the INDEC (the argentine equivalent to BLS) so it can manipulate the CPI at
will. As result, “official” inflation is less than half than what is reported
by any other estimation. The manipulation was so obvious that government
persecuted any other economist who dare to defy what government says is the
“real” inflation. No layman in this country believe in government statistics,
only government-paid Goebbellian propagandists and government “economists” think they are real. Not
surprisingly, Argentina’s money supply increases at an annual rate around
20-30%, part
of it is to finance public sector deficit.
Now in
order to not take the blame, the government and its minions have revived a lot
of old fallacious explanations about inflation. Only one of them is the “blame big-business” fallacy.
According to government, there are “price formers” that abuse workers and
consumers by rising prices. That
is just an unscientific and ridicule denomination for a most “serious” theory
that tries to explain inflation without recurring to money supply. That is the
fallacious theory called “administered price” or “control over price”. According
to Hazlitt and Sawyer, this term was invented by Gardiner C. Means in 1935. However it has already been refuted.[1]
This
theory says that a big company has an unrivaled power to raise price, it can
even defy the Law of supply and demand. The theory implies that only by setting a
selling price is enough to realize that “manipulated” price in market. So if
price level goes up it is possible that this firms are charging “too high
prices” and creating inflation. It is not a surprise that some of its
supporters use it to deny the existence of demand-supply price determination. Now
this theory has so many problems that it is amazing it can be taken seriously.
In the real world free market there
is no such thing as a “control over price”. However somebody will say...
-“They control us!”
No
they don’t. In a voluntary
exchange nobody “controls” price. The main reason why a price emerges is
because there is another part,
it’s a mutual phenomenon,
Robinson Crusoe alone in his island cannot exchange with anyone. In a free
exchange, each part has no control
over the other part. If seller cannot control the buyer then all he can do is
to induce him to buy. If
buyer cannot control the seller, all he can do is to induce to sell him the good or service. Now in order to
induce each other in a nonviolent way, both parties can a) try to hypnotize the other part b) try to convince the other part to give away the good c) offer something in exchange. In any case there must be a common factor that is a necessary and
sufficient condition for exchange to exist: both parts must win.[2]
Option c) will be chosen in the great majority
of cases because is the least expense and the most efficient. If this happen,
then in order for the buyer to ensure he will get the good, he will have to
give a quantity of another thing he can offer. If the quantity (price) he offers
(or the one the seller ask) satisfy his subjective valuations (i. e. is valued
less than the goods he expect to receive) and at the same time the quantity
asked by the seller (or offered by buyer) satisfies him, then the exchange will
be fulfilled.[3]
Assume you want
to sell your old car. You can ask one jillion dollars for it if you want. But if
nobody buys it, then you can lower the price or not sell the car at all. It is
possible that, in an incredible coincidence, your old car was Marilyn Monroe’s
first car and someone actually pays that money. It could happen, as well as
there are people that ask a ridicule high price because they are not desperate
to sell.
All this demonstrate
that in an exchange there is no control over price, an exchange is voluntary
and the price emerges as mutual valuations interact each other. The seller can raise
the price as much as he wants and the buyer can lower it as much as he wants,
but as long as one part cannot control the other part, he cannot get the
maximum or minimum price he would desire.
-“Yeah yeah, voluntarism sounds good. But what about the big ones!”
This argument states: Look
at Ford, Microsoft, Walmart, General Motors, they are so big! How can you
compare them with a farmer, a little kiosk or retailer, or some small business?
They are price takers! They have to face a given price while Ford can control
price. It is big, it has scale, it has a branches and a name. Even if they don’t
have an absolute monopoly, they have a degree of monopoly power.
Sounds
convincing, but guess what? Both the big and the ultra-small business can
actually have absolute control over the quantity they are willing to produce and the price they ask. Both groups of sellers can ask hyper-higher prices and
restrict their production. But none of them can control how much buyers are
willing to pay. Could Ford have asked one million dollars for each Ford T he
made? Yes he could, he probably could have produced 5 cars a year. Can the
farmer ask five times the market price? Yes he can. Are there people willing to
pay that knowing that they can obtain the same good at lower price from another
farmer? Hardly. But you may say: “Don’t be a fool. You are comparing a competitive
atomized market like wheat with an evil big monopoly corporation like Ford, you
have no alternative to buy another car, only Ford’s. In wheat market however
you have millions of farmers selling the same good” Of course you have
alternatives even assuming that car’s price is “administered” too high! You can
ride a bicycle, a horse or a bus. In general when you buy a car you are buying
individual transportation, the reason you buy it is because you expect the
benefits of using your own car surpass the costs of purchase and the costs of
other alternatives. If its price is too high, you can use the individual
transportation you have been using like your bicycle or your own legs. Or you
can use a public bus or subway. The good you are looking for is, in general[4],
transportation, not the car
itself. The car is just a form of transportation, so it is not true that “you
have no other alternative than buying Ford’s cars to transporting yourself”. It
is not crazy at all to compare an “atomistic-competitive market” and Ford. In
both cases they can ask extremely higher prices and in both cases you are not
forced at all to pay them.
A seller cannot control buyer’s
willingness to buy and (mutastis mutandi) viceversa! All that both can control
is the price they ask, but they cannot control that the other part pays what
they want (maybe
the Hypnotoad can, but nobody else!).
The ultimate
fact that confirms this is that every single one of us (including big business
men, presidents, scholars, professionals, wage earners, everyone!) would like
to sell our goods or services (wages, salaries, rents, interest, price of
goods, etc.) at a higher price. What prevent that to happen? The fact that our
buyers will not pay those prices (and the fact that the “control over price” is
totally false!)
-"Have you ever gone to Walmart? The prices are there! Walmart determined
them!"
Yes! When you go
to Walmart the prices are there “fixed”. But the one who set the price is not determining
the price. A big enterprise can set
the price, but the ones that corroborate that price are the consumers. The ones
that determine prices are the consumers. It is a totally irrelevant
technological question how or how often prices are set. Whether you are in an auction,
in a supermarket, eBay, etc.; it is always subjective valuations what determine
price. Institutional arrangement does not at all alter the fact that prices are
determined by value scales of suppliers and demanders. What would happen if Walmart
set a 40” Full HD LCD price at U$S1? I think you know the answer: a lot of
people will run to Walmart to buy one. When the avalanche of people arrives and
Wal-Mart sell the first 100 TVs, it will have to a) restrict the quantity of TVs to sold unless they want to
confront an imminent shortage or b) raise
the price in order to stop the avalanche. Obviously option b) is the most convenient, Walmart want to earn more knowing that
it can sell all existence at a higher price rather to sell less at the same hyper-lower
price. Actually it is even possible that customers themselves will offer a
higher price, everyone knows that even offering to pay $20, instead of $1, it
is still a great deal to buy a 40” LCD. There you have it: The great super big
transnational oligo/monopolist Walmart having no choice but to adjust itself to
the Law of supply and demand.
Another example
is offered by Salerno here (around minute 40:00): the first week in which a
movie is released, you see people lining up in cinema. In this first week the
cinemas could raise price and dispense the line. Why don’t they do that? Because
they will lose “good will” that is worth more than the money they can earn that
week by raising price. Despite the fact that cinema can raise price and make profit from it, it
will not do that because business men know that people will think: “Do these guys
think I’m going to pay more today to see a movie that I can see next week
cheaper? Besides, why I should pay a higher price today? This people are trying
to exploit my need to see that movie.” Moreover a line is very useful to the cinema because draw attention, is a form of advertising. But you must note that the cinema cannot control the price
without violating consumers sovereignty. Raising price to deal with the great
demand from the first week of the movie has a cost: the cinema loses “good
will”. It will lose clients acting by that way. So it must adapt itself to what
consumers want. There is a hidden non-monetary cost which is the subjective
valuation of the cinema's owner who estimates that he will lose clients by raising prices the first week of a premier. We still see perfectly well how subjective
valuations of sellers and buyers determine cinema ticket price. There is no
“administered price” here, not even in this example of an apparent non-maximizing monetary profit behaviour of the
firm which could have earned more by raising price. Even here we see consumers approving or not firm’s “fixed price”, even here we see consumers approving or not business price.
“Producers set the price, but consumers, by buying or
abstaining from buying, are the final decision-makers as to whether the price
set will lead to a profit. Producers in this regard are at the total mercy of consumers.”
“Businessmen experiment with
various prices on a trial and error basis. Experience and market studies
furnish some clues, but the best they can do is to select a tentative price for
their good or service on the basis of their best estimate of what consumers
will pay per unit. This becomes their "asking price." This
"asking price" may appear to be "fixed" or
"administered." They may print this "asking price" on their
product's label, list it in advertisements and even instruct their salesmen to
quote this price to potential buyers on a take-it-or-leave-it basis. However,
this "asking price" is actually just the first step in trying to
bring about a trade that will be mutually satisfactory. If a businessman wants
to sell his entire stock eventually, if he wants supply and demand to come out
more or less even, his "asking price" cannot be considered as
permanent or "fixed." Nor can he "administer" prices. If he
does not enjoy a specially privileged position, protected by government from
competitors, it is the businessman's potential customers who can say "take
it or leave it," refuse to buy from him and look for substitute goods and
services. Thus if the businessman wants to sell, he must remain flexible and
willing to raise or lower his "asking price" according to the wishes
and whims of consumers, as they express them on the market.
Whether the would-be seller
of a product is a large corporation, be it General Foods or General Motors, or
a peddler in a Middle East bazaar, he is always at the mercy of consumers on a
free market.”
-"But I mean that Ford is so large that his actions affect great part of
the market, so he can control the price."
This only means
accepting the fallacious doctrine of monopolistic competition.
-"Come on! Have you seen how prices are determined in a company? They are
cost-determined prices."
The theory that establishes
“costs determine prices” has been refuted many times, as well as the myth of
“cost-push inflation”. Böhm-Bawerk specially deals with the problem that our
daily experience apparently sees that any business set the price by just making
a summation of all costs and adds a margin. However, and this is a very
fundamental thing, a business man have been willing to incur in costs today
because he expect to sell the product at a future price that covers his costs
and give him a margin. It is the (expected future) price what determined his
(past incurred) costs, costs do not and cannot determine prices. A producer of
a good has spent $450 only because he expected to sell the good in future at a
price of, say, $500 or more. If he expected to sell it at a price of $400 he
would not have incurred in costs, the expected price determined his spending (or
not spending) in costs. He estimated that price according to his anticipations about
subjective valuations of his potential demanders. He is estimating how much his customers would pay; but he is not making them pay. According to
his estimation of future prices, entrepreneurs spend today (or not) in costs.
Actually they are willing to incur in costs only up to the price they expect to
obtain, the expected price is the limit. As Bawerk says: “It runs, in the clearest possible way, in an unbroken chain from value
and price of products to value and price of costs—from iron wares to raw
iron, and not conversely.”
What we observe
in some business is the rule of thumb of adding costs and putting a mark-up, so
they apparently “fix price” the good. But that is not controlling price! You
can put the price you want, but until a guy comes along and put the dollar to
pay what you ask, there is no price that is worth. It is totally irrelevant the
price that the firm fix. If after 3 weeks he have not sold the product, either
because consumers buy it cheaper in other place or decided to not buy at that
high price, he cannot remain obstinate and he will have a decision to make:
either he reduces the price until people come to buy or he goes bankruptcy. Big
companies do not “fix prices”, they usually have price departments that are
continually alert about how stocks moves (which product have been bought a lot
and which have not), and change prices (up or down) accordingly. By “trial and
error” they are permanently estimating the price which is in accordance to the
subjective valuations of marginal pairs. What superficial observers see as “controlling
or fixing” price is actually a method to estimate a price determined by
subjective valuations of “marginal pairs”.[5] Not only is this process in
completely agreement with consumer sovereignty, this “society of one-price” is
an institution created to avoid the enormous costs of negotiation in an
isolated exchange, it saves time that could have been used in negotiating each
price. Big business introduced this “ask price” system in the beginning of
century and was such a success that it has become a daily reality. This
institution facilitates to find the market price determined by subjective
valuations of marginal pairs. Only a very superficial observation can make
someone to think that it is business which fixes prices.
But even a very
little quota of common sense can demonstrate the wrongness of the “administered
price” doctrine. If world were so easy that any company just have to make a
cost + profit (mark up) = price equation and just sell, then all of us (workers,
landlords, etc.) would be big business men. I myself would start a company that
produces pencils and fix myself a $10.000.000 (or 100.000.000! why not?)
monthly wage. I would contract all my friends and people I like and I would pay
them $200.000 to work with me, and of course I would hire this secretary at a
wage of $4.000.000 monthly. Notice that, with this “structure” of costs, the pencil I would sell should
have to have an extremelly expensive price (especially because I would add a
500% rate of profit to the costs, why not?) and I doubt all my friends are good enough
at the tasks that the production of a pencil would require. So despite the
extreme price, the quality of the pencil would not be so good. Now, does anyone
think that the above scenario is feasible or probable? Is someone going to buy
the pencils? Of course not! All I did was to use the cost + profit = selling
price formula to do business. The fact that everyone agrees that the above
example is ridicule is the best prove that entrepreneurial activity is not just
about passing cost + profits value to consumers. It does not matter how many
costs you add to produce a good, if people does not pay for it, you do not
control its price. Contrary to this theory, it is consumers' willingness to buy what decides that the price set
will lead to profits or not. In adjusting price to this, the producer must
adjust his costs to make a profit.