Economics 101

How Do You Know If Prices Are Fair?

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How are prices set in our economy, and are such prices legitimate, or just—especially in times of crisis, like a hurricane?

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 and ice prices during and after Hurricanes Harvey and Irma legitimate?”

How Do Prices Work?

We talked about the role of prices in a recent blog post, but here 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 finite resources by sending us signals about the relative availability of the things we need and want.

Stewardship: Genesis 1:27-28 says,

God blessed them and said to them, “Be fruitful and increase in number; fill the earth and subdue it. Rule over the fish in the sea and the birds in the sky and over every living creature that moves on the ground.”

The scarce resources God has endowed us with have many competing purposes. As good stewards, 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.

Cooperation: Philippians 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. In The Use of Knowledge In Society, he writes: “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 You Set Fair Prices?

Market-generated prices 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 that change the availability of scarce resources. Hurricane Harvey eliminated about 25 percent of the oil supply off the Gulf Coast. The short-term ability to produce gas has been 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. Keeping the price of gas artificially low 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.

Economist Michael Munger provides a powerful lesson in what happens when we don’t understand scarcity, incentives, and the function of prices. The result is that we make decisions and act in ways that harm us and others. He uses the example of the price of ice after a hurricane and explains that price ceilings effectively solidify scarcity:

What if you pass an anti-gouging law, to symbolize your opposition to scarcity? Let’s abolish scarcity; what then?…All a state accomplishes by passing an anti-gouging law is to ensure that there is no ice. I can’t get it for $100, or $1,000.

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. If the market is allowed to send resources to the areas where there is high demand, competition will ensue and prices will drop, just as they would in any other part of the economy.

Editor’s Note: To learn more about prices, profits, and greed, see IFWE’s newest book, Counting the Cost: Christian Perspectives on Capitalism.

Help more people learn about biblical stewardship and the economic way of thinking! Donate to IFWE today. 

 

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  • Kelly Madden

    First, I love your posts. I learn so much! I have so little training in economics.

    Now I will pick two nits.

    “Scarcity” is a technical term in economics, I’ve come to understand. But it’s usually used by economists without explanation, because, I suppose, the specialized definition is so common to them.

    The first dictionary definitions of “scarcity” usually refer to something being in “short supply” or some such. Implied: most people cannot get enough of it to meet their desires at a price they are willing to pay.

    Whereas in economics, scarcity means merely that the supply is “limited.” Most people may be able to buy it readily at a price they are willing to pay to satisfy completely their desire for it. But there is a finite amount of it, nonetheless.

    Water is a good example. Most Puerto Ricans wouldn’t have called potable water “scarce” before the hurricane.

    You should signal that difference in definitions, it seems to me. It would save a lot of misunderstanding.

    Second, you should also refer briefly to unfair constraints on supply, such as state-sanctioned monopolies, or the ability of companies to effectively eliminate competition by manipulating regulation, or by extortion of their competitors.

    I seem to recall that the wife of the president of an African nation owned the only cell phone company licensed to operate in the country. With predictable results on the price of a cell phone contract.

    Organized crime syndicates have often eliminated their competitors in garbage collection, metaphorically or physically.

    In times of crisis, this kind of injustice is much more likely to go unpunished even by otherwise-just civil authorities, whose capacities are overwhelmed.

  • richard silliker

    If it were only that simple, rather then simplistic. Human behaviour is complicated, not complex.

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