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The importance of prices

By Andrew Badinelli
web posted November 25, 2013

Let's face it, every day we all hear at least two things.  We hear a disagreement, and we hear a complaint.  People disagree about politics, about movies, about books, about religion, about music, and about other people.  And people complain about politics, about movies, about books, about religion, about music, and about other people.  However, when you combine both disagreement and complaining, something miraculous happens: we finally agree on something; we agree to complain. And nothing garners more human complaint than prices.  Consumers complain when prices go up, producers complain when prices go down, and neither is happy if prices stay the same.  Prices unite people under a common banner like nothing else can.  However, there are misconceptions about what prices really are, which is what Dr. Thomas Sowell addresses in his book, Basic Economics.

In Chapter 2, The Role of Prices, Dr. Sowell makes a simple yet potentially controversial statement; he writes, "Prices are not simply ways of transferring money." A mere seven words, but contained therein is the power to spark a, you guessed it, a disagreement. "But when I go shopping, I give my money to the cashier; I'm transferring my money!" cry the consumers. "And when I sell children's toys at my store, people are simply transferring their money to my business!" state the producers.  Dr. Sowell, does not refute this, he merely goes a step further.  Dr. Sowell argues that prices provide the incentives which affect the behavioral use of resources and their resulting products.  For example, the folks at Apple cannot possibly know what millions of different consumers want in the new iPhone. However, they do know that when they sell the iPhone with certain features, people buy their iPhones ferociously, thus leaving Apple with a profit.  Conversely, certain features may cause their iPhones to be unpopular and not sell as well (at which time consumers flock to Samsung).  In order to get rid of the unsold iPhones, Apple then cuts their prices and takes a loss. Dr. Sowell argues that this one of the bases of a market coordinated by price movements (i.e. capitalism). 

Essentially, prices can have two different outcomes: profits or losses.  Each outcome serves as an incentive.  Profits serve as an incentive to the producers to continue their business practices; losses serve as an incentive for producers to stop doing what they are doing.  Profit is a green light, while loss is a red light. What this leads to is market self-regulation.  If producers do not listen to the traffic signal of loss (red light) that producer will go out of business, thus eliminating from the market the product which consumers did not want in the first place.  Guided by the desire to make as much money as possible, producers equitably distribute scarce goods throughout all sectors of society. Thus, prices guide economic production in the most efficient way possible.

Dr. Sowell presents an argument on the on the power of prices which is hard to refute.  Even in my own personal life, I have seen this economic principle in action.  My life can (loosely) be seen as a micro-economy.  Whenever I take certain actions, I pay prices.  If I do something good, the price the consumers (my parents/employer) are willing to pay is higher than say, if I do something not so good.  The prices vary depending on the action I take, therefore incentivizing me to repeat certain actions and discontinue others; I make a profit if I do something good and take a loss if I do something wrong.  Prices influence choices, one of the main focal points in economics.

Prices are not simply arbitrary numbers assigned to products in order to facilitate their movement in the marketplace.  Prices guide the marketplace; through the system of profits and losses, prices run the marketplace in the most efficient way possible.   We all need to realize that the role of prices is much more than meets the eye, which, unfortunately, might just give us something else to complain about. ESR

This is Andrew Badinelli's first contribution to Enter Stage Right. © 2013 Andrew Badinelli

 

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