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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  • Jim Price

    The photo in your blog tells quite a story in itself. The price of gasoline seems to have no ethical justification; recent increases appear to be contrived and not driven by shortages. My point is that only a few think of the moral reasons for prices and many more think of ways to charge whatever the market will bear.

    Recently, I bought a 48 inch, high definition TV, it was made in Mexico, sailed into the port at New Orleans and finally trucked a thousand miles to my home. At the same time, I had a root canal, a mile away at the dentist. The dentist charged $ 1,100.00 for just over an hours labor, within dollars of what the TV cost.

    I salute, what you and tifwe do but fear, that the economic trend is in another direction.

  • You can also insert the fact that this is only possible within a free market. For the free market allows competitors to arise which forces the sellers to be where buyers are. BP cannot keep gas prices above supply because Exxon will move their prices more closer to the supply price to get the customers. Competition keeps the market honest.

    Here would be a important article: How government influence on prices leads to more poverty and over all decline in the economy. For most people it seems like a plus when they get paid more and certain food items stay at a certain low price amount. It would be helpful to have the full implications of government subsidies fleshed out for common people to see. But just a suggestion. (I would love to but I don’t have a Ph.D in economices)

  • ‘All market-generated prices are just.’- is this true? Suppose there are just two people on a desert island. One has both food and water, the other has nothing but a bag of gold. It may be that compelled by thirst, the latter trades all of his gold for a little water after drinking which he perishes of starvation.

    This is a market transaction- indeed, it could be said to be somewhat altruistic in that the other party could just have waited till the thirsty man died and then taken his gold without making any payment.

    Would we call this price just?

    My feeling is that it is the essence of a market transaction that it is not a one-off but a repeated game with potential positive sum outcomes. Indeed, prices serve no signalling function if transactions are one-off.

    The Quaker Economist, Kenneth Boulding- author of numerous beautiful hymns- laid emphasis on the sort of positive ‘psychic capital’- trust, mutuality, goodwill- created by markets working on the basis of repeated transactions engendering long term mutually beneficial relationships. The true wealth of a Nation lies in this sort of psychic capital. Good business practice fosters a good Legal and Administrative infrastructure. The ‘robber baron’ approach of oligarchs, on the other hand, goes hand in hand with corrupt Politics and a dysfunctional Legal system. Long term, there is both ‘capital flight ‘ and ‘brain drain’ from such countries. People vote with their feet an migrate to more salubrious environments.

    From the Christian p.o.v. the notion of just prices, at least under conditions of imperfect competition- i.e. the sorts of markets that obtain in manufacturing and services where product differentiation or local monopoly/ monopsony exists- and asymmetric market power- can lead to better business practice, more ‘X efficiency’ and greater dynamism in the exploit of potential economies of scale and scope.

    More generally, a notion of just price can be rigorously specified as that which would obtain as the correlated equilibria in a repeated game such that all exigent circumstances were insured against- i.e. arbitrageurs operate in the market in a manner to equalize risk premiums.

    Govts. aren’t really going to be able to compute that just price and are likely to create deadweight efficiency losses if they intervene in markets for populist reasons. The Shah of Iran lost his throne because he attempted to bring down the price of bread by throwing innocent bakers in jail. Needless to say, he took no action against the greed and profligacy of his own supporters whose reckless spending was responsible for inflation.

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