Economics 101

How Do We Set Just Prices?

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How do prices emerge in a market economy, and are such prices legitimate, or just?

The theory of just prices is considered an “ethical theory” of economics. It dates all the way back to Thomas Aquinas.

This theory questions the legitimacy of certain prices. It is often based on the labor theory of value:  the labor justifies the price, rather than the intersection of supply and demand. Just price theory asks questions such as, “Was the increase in gas prices after Hurricanes Katrina and Sandy legitimate?”

Questions about just prices lead us to Principle #6 in our series on the biblical foundations of economic principles: prices bring the choices of buyers and sellers into balance.

How Do Prices Work?

The authors of Common Sense Economics do a great job of helping us understand how prices work:

  1. Market prices influence the choices of both buyers and sellers. No one party has absolute control over the other.
  2. When a rise in the price of a good makes it more expensive for buyers to purchase it, they normally choose to buy less of that good. For the buyer, there is a negative relationship between the price and the quantity demanded. This is the Law of Demand.
  3. For sellers, a rise in price of a product makes them more willing and able to supply more of it. For the seller, there is a positive relationship between the price and the quantity they produce. This is the Law of Supply.
  4. The intersection of the supply and demand curves gives us a market price.
  5. As long as that price is between the maximum the consumer is willing to pay and the minimum offer price of a seller, potential gains from trade are present.
  6. Thus, prices reflect the relative scarcity and value of our resources.

What are the implications of these economic principles? Market-generated prices (the result of steps 1-6 above) bring the quantity demanded and quantity supplied into balance. They also direct producers to supply the goods that consumers value.

Biblical Premises for Prices

There are several biblical premises relating to prices:

Scarcity: Scarcity is an inseparable part of the human condition. We must always make tradeoffs because of this. Prices help us ration our scarce resource by sending us signals about the relative availability of the things we need and want.

Stewardship: Colossians 3:23-24 says,

Whatever you do, work at it with all your heart, as working for the Lord, not for human masters, since you know that you will receive an inheritance from the Lord as a reward.  It is the Lord Christ you are serving.

The scarce resources God has endowed us with have multiple and competing ends. We must make tradeoffs: should we buy another car or send our child to private school this year? Market-established prices help us make these tradeoffs between resources.

CooperationPhilippians 2:3-4 tells us:

Do nothing out of selfish ambition or vain conceit. Rather, in humility value others above yourselves, not looking to your own interests but each of you to the interests of the others.

God calls us into community to work with and serve one another. Prices guide us in serving others by coordinating our activities. They also give us signals about how to best serve each other.

Friedrich Hayek recognized this coordinating power of prices. He wrote in The Use of Knowledge In Society that,

Prices can act to co-ordinate the separate actions of different people…

Prices help us attain a level of flourishing that otherwise would remain unknown. They harness decentralized knowledge.

How Do We Know Prices Are Just?

All market-generated prices are just. They are just because they are voluntarily achieved through interactions between buyers and sellers. Buyers tell producers what they want, and producers use up scarce resources to meet demand.

In a fallen world, unpredictable things happen which change the availability of scarce resources. Hurricane Katrina eliminated 50% of the oil supply off the Gulf Coast. The short-term ability to produce gas was more difficult. In this situation, just price theory might lead us to support a price ceiling that limits the price of gas from rising too high. This would have significant unintended consequences:

1. Artificially lowering the price of gas tells producers that gas is widely available, and doesn’t need to be produced – exactly the opposite of reality in this situation.

2. The artificially-low price of gas also tells consumers they don’t need to think about conserving fuel. If gas prices are high, consumers see gas is a rare resource. They’ll use less of it.

Regulations such as price ceilings, price floors, minimum wage, rent control and price subsidies are prices achieved through coercion (meaning they are set externally by the state). This is not just, even when such controls may be well-intended. They are unjust because they reflect what one group wants, and coerces others to give them. A market price reflecting the value one has created with their talents and skills is just.

The only way to get a just price is to let the market signal to us where to allocate our scarce resources, and allow prices to immediately respond to the often tragic scarcities that afflict life in a fallen world.

What do you think determines a just price? Leave your comments here

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