We use prices everyday but we don't think about what they mean. Prices simply reflect an abundance or a scarcity. They also play a very important role of allocating resources (meeting a demand with a supply.) What does all this mean? Well lets take a closer look.
As you know from my previous post, prices are a big difference between socialism and capitalism(free market economy.) They are also a main reason socialism Always fails.
The Last premier of the Soviet Union Mikhail Gorbachev once asked British Prime Minister Margaret Thatcher: How do you see that people get food? The answer was she didn't, prices did that for her. Those British people ate better than the Russians, even though the British have never grown enough food to feed themselves in more than a century. Prices bring them food from other countries.
To explain this next part i will refer to "Basic Economics" by Thomas Sowell.
Sowell writes; If the government were to come up with a "plan" for "universal access" to beach-front homes and put "caps" on the prices that could be charged for such property, that would not change the underlying reality of the high ratio of people to beach-front land.
With a given population and a given amount of beach-front property, rationing without prices would now have to take place by bureaucratic fiat, political favoritism or random chance-but the rationing would still have to take place. Even if the government were to decree that beach-front homes were a "basic right" of all citizens, that would still not change the underlying reality in the slightest.
Prices are like messengers conveying news, in the case of beach-front property its bad news.
(Because of the scarcity, the price is higher. This is necessairy for rationing, the price is set by the demand of the market.)
Prices not only guide consumers, they guide producers as well. When all is said and done, producers cannot possibly know what millions of different consumers want.
While a free market system is sometimes called a profit system, it is really a profit-and-loss system and losses are equally important for the efficiency of the economy, because they tell the producers what to stop producing. Without really knowing why consumers like one product rather than another, producers automatically produce more of what earns them a profit, and less of what is losing money. Although the producers are only looking out for themselves and their companies' bottom line, nevertheless from the standpoint of the economy as a whole the society is using its scarce resources more efficiently because decisions are guided by prices.
Something to keep in mind: The efficient allocation of scarce resources which have alternative uses is not just an abstract notion of economists. It determines how well or how poorly millions of people live.
From the standpoint of society as a whole, the "cost" of anything is the value i has in alternative uses. The cost of building a bridge are the other things that could have been built with that labor and material.
Now back to the U.S.S.R to illustrate another point. The Russians admitted this information. The production enterprises in the U.S.S.R always ask for more than they need in the way of raw materials, equipment, and other resources used in production. They take everything they can get regardless of how much they need, and don't worry about economizing on materials. After all nobody at the top knows exactly what the real requirements are, so squandering makes sense. Among the resources that get squandered are workers. Economists reported that from 5 to 15% of the workers in the majority of enterprises are surplus and are kept "just in case."
The consequence was that far more resources were used to produce a given amount of output in the soviet economy as compared to a price-coordinared economic system, such as that in the United States. Citing official Soviet statistics, Soviet economists lamented:
We use 1.5 times more materials and 2.1 times more energy per unit of national income than the United States. We use 2.4 times more metal per unit of national income that the U.S.
In a price-coordinated economy, employees and creditors insist on being paid, regardless of weather the managers and owners have made mistakes. This means that capitalist businesses can make only so many mistakes for so long before they have to either stop or get stopped-whether by an inability to get the labor and supplies they need or by bankruptcy.
In a feudal economy or a socialist economy (which is pretty much an oxymoron, socialist economy), leaders can continue to make the same mistakes indefinitely. The consequences are paid by others in the form of a standard of living lower than it would be if there were greater efficiency in the use of scarce resources.
The final facet of pricing i want to cover in this post is. The face that people demand more at a lower price and less at a higher price may be easy to understand, but it is also easy to forget.
In our society we have begun to believe certain fallacies. For example we blame high prices on "greed." People then speak of something being sold for more than its "real value," or of workers being paid less than they are "really" worth.
To treat prices as resulting from greed implies that sellers can set prices where they wish, that prices are not determined by supply and demand. It may well be true that some -or all-sellers prefer to get the highest price they can. But it is equally true that buyers usually wish to pay the lowest price that they can for goods of a given quantity. More importantly, the competition of numerous buyers and numerous sellers results in prices that leave each individual buyer and seller with little leeway.
Here is a great example:
When some natural disaster like a hurricane or a flood suddenly destroys many homes in a given area, the price of hotel rooms in that area may suddenly rise, as many people compete for a limited number of rooms, in order to avoid sleeping outdoors or having to double up with
relatives or friends, or relocate outside the community. People who charge higher prices for hotel rooms, or for other things in short supply in the wake of some disaster, are espically likely to be condemed for "greed," but in fact the relationship between supply and demand has changed. Prices are simply performing one of their most important functions-rationing scarce resources.
If prices had remained at their previous levels after the disaster, a family of four might well rent two rooms, one for the parents and one for the children. But when hotel prices shoot up well beyond their usual level, all four family members ma crowd into one room in order to save money, leaving the other room for other people who have likewise lost their homes and are equally in need of shelter. If the government imposed price controls on this hotel, then the first to get to the hotel would take up more space and leave less of others, leaving more without a place to stay.
In short prices force people to share weather or not they are aware of sharing.
Coming soon, Price controls the exciting kind.
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