How Prices Are Determined
[Understanding the Dollar Crisis (1973)]
There was once a Russian school child whose cat had a family of kittens. When asked to write a paper for her class, the child wrote about the mother cat and the kittens. The next day she read her paper to the class. In it she told about how these kittens were born. There were five of them and they were all good little Communists. The teacher liked the paper, and when, a week later, one of the Moscow inspectors visited the school, the teacher, proud of her pupil, asked the child to read it again. The child read the paper. When she came to the part about the kittens she said there were five kittens and two of them were Communists. The teacher was quite surprised. The child had previously said all five were Communists; so the teacher asked the child why she had changed it. "Well," the little girl said, "three of them have opened their eyes."
One of the things we are trying to do in these lectures presented by the Centro de Estudios sobre la Libertad is to open the eyes of people who have heard so much about the promises of socialists and government interventionists to use political power to improve the economic situation of the poor, the sick, the young, the aged, and all others with whom they seek popularity. Actually, the only way for governments to improve the economic condition of their citizens is to provide equal protection of life, property, and the marketplace for everyone, while peacefully adjudicating disputes which might otherwise lead to frictions and infractions of the peace. Using the force of government to take from some to provide special privileges for favored groups will never improve the general welfare. Governments that play favorites sow the seeds of their own destruction and reduce the production of both the poor and the rich.
For each of us, life is a problem of how to use our limited means to produce more of the things that provide us and our loved ones with the greatest possible satisfaction. We daily strive to satisfy our most important wants before we try to satisfy those we consider less important. In short, we constantly seek to improve our situation by exchanging something we have for something we prefer. The prime function of government is to provide an atmosphere in which more and more mutually beneficial exchanges can take place.
Division of Labor
As individuals we cannot produce all the things we want. So we tend to specialize, and produce things that other people want. We then exchange the products of our efforts in the marketplace for the things that we want. This involves what economists call the division of labor.
In his great book, The Wealth of Nations, Adam Smith, the founder of English classical economics, tells how we can all have more if we specialize and trade. As mentioned in our previous lectures, it is our value scales that direct us in making our choices of how to use our limited means to attain more of the things we want most.
If man finds it easier to get what he wants by specializing his contributions and trading his specialties with those who produce what he wants, he will do so. He will take the easiest way he knows to improve his situation. Consequently, civilized men have resorted to specialization in production and the subsequent trading of the specialties they have produced. Such trading necessitates the use of a medium of exchange, or money. In our fifth lecture, we shall be dealing with that very serious part of the market problem. But it is money prices that we are talking about now. Most people are confused about prices. They seem to think that prices are set by producers and sellers, that they add up their costs and then add something more for their profit. This is how most people think prices are set.
Actually, the successful businessman looks for something that the people want, something he thinks he can produce for less than people will pay for it. So in the final analysis it is the values businessmen believe people have in their minds that determine what goods they will make, and how much they will make of each particular scarce good.
This question of what to make is one of the important problems that the socialists neglect. Marx thought there was no such problem. So did Lenin. They thought the only businessmen you needed were bookkeepers to keep the accounts. Nobody had to decide what needed to be produced. This was supposedly evident to everyone. The masses needed more food, more clothing, and more housing. For Marx and other socialists, the choice of what to make was no problem at all.
But this, of course, is not so. We cannot make everything people want. The most important decisions in this world are those that determine what should be made and what should not be made. These decisions seek to determine what things give the greatest human satisfactions, so that our scarce means of production are not wasted making things that people do not want as much as other things that could have been made with the available supplies of labor and raw materials.
In a market society, individual subjective values allocate the available supply of every scarce good so as to satisfy human wants in the descending order of their importance, whereby the particular want last satisfied is the one with the marginal utility. From beginning to end, price, and thus economic calculation, is the product of subjective valuations. Price is the result of the reciprocal impact of the subjective values placed on the good and on money by all interested parties. The resulting market prices must benefit all who exchange.
As we have said before, but should never forget, all life is a series of choices whereby we try to exchange something we have for something else that we prefer. The fewer the obstacles placed in our way in the form of higher costs, taxes, or other governmental interventions, the more exchanges we can make for the mutual advantage of all the participants.
The Economic Problem
We are constantly faced with the economic problem. The economic problem is, of course, the problem of human beings, the problem of life. This problem is how to employ our available means in such a way that no important want is left unsatisfied because the means for attaining it were used to satisfy a less important want. Such a misuse of scarce means would provide less human satisfaction. It would be wasting valuable wealth. Acting man wants to know how to use what he has to provide the greatest attainable human satisfactions. This is the problem that concerns all of us. This is the problem that the market solves.
In trying to get what we want, we are directed by our ideologies. Ideologies are our ideas about how we think society operates. Sometimes we are influenced directly by an ideology. If we believe certain actions will produce the results we want, we take those actions. Ideas, as we stressed in the first lecture, are very important. But sometimes in our social activities, an ideology influences us indirectly. We follow certain procedures which by themselves we do not consider very helpful, because we do not want to offend those around us. We go along with certain widely held myths, certain popular prejudices, or certain accepted folkways, rather than take the actions we consider most efficient. We do this because we have to live with our fellow men and cannot always do things that we ourselves might consider best.
For a good to have value it must assure the satisfaction of a need or want of some human being. Thus, if that good did not exist, there would be some human want that would have to go unsatisfied. Every loss of an economic good means that there is one less human satisfaction attained. Goods can have a direct value, that is a use value, to us. Or they can have an indirect value, that is an exchange value, which means they have a use value to someone else. In that case, we can exchange them for something which has a use value to us.
In the marketplace it is the use value or the exchange value, whichever is greater, that determines our choice of actions. When we see something that is more valuable to us than its market price, we buy. When we have something that is more valuable in the market than it is to us, we sell. We do not trade for the fun of it. Otherwise we might trade back and forth all day long. We consider every exchange, every transaction, beforehand, and we continue exchanging up to the point or limit beyond which we do not expect to gain any further.
Trade Increases Wealth
Since all men are eager to satisfy their more important wants, those which are higher on their value scales, before they satisfy their less important wants, those which are lower on their value scales, they trade whenever they can find anyone who has opposite or contrary views on the relative values of two goods or services. By an exchange transaction, each good or service moves to that person who places the higher value on it. The wealth of each party is thus increased. They have both gotten a psychic profit, that is, a gain that they themselves consider a profit. This psychic profit cannot be measured, but it is a very real increase in satisfaction in the minds of the parties participating in the exchange. Market exchanges are not equal exchanges. They are unequal exchanges, from which both parties expect to gain.
So trade is productive of value. In a market economy goods are constantly moving from those who place a lower value on them to those who place a higher value on them. This is a fact of economic life that is not taken into consideration by mathematical economists. They seem to think that economic goods have a certain fixed value, usually based on the cost of production. They calculate this value as an unchanging fact, not realizing that when a good shifts from one person or place to another its value has been increased. The physical goods have greater value when they are owned by people for whom they can provide greater satisfaction.
It is the unequalness of the use and exchange values of different people that leads to exchange. These differences cannot be measured, only compared. They are in the mind. They are psychic. It is always a matter of greater or less. If the value of what you expect to receive is not greater for you than the value of what you will have to give up, then there is no trade. The differing use and exchange values of different individuals result in the emergence of prices — market prices. There are no other kinds of prices, only market prices.
Most scarce goods have many uses, or a use value for many people. The economic problem is to allocate them so as to give more human satisfaction to all concerned. Voluntary exchange is the only possible way in which all can benefit. It is the only system that allocates each scarce item to that use or person where it has the highest relative value. It is the only system that tends to minimize waste and maximize human satisfaction.
How Men Act in the Market
In life we are faced with two questions as we go to the marketplace. These questions are whether or not to exchange, and if so, on what terms. The answers can be simple. There are three rules or postulates for answering these questions:
1. Man will exchange only if he can exchange for an advantage.
2. Man will exchange for a greater advantage, in preference to an exchange for a lesser advantage. If you can buy something for 250 pesos, you are not going to pay 275 pesos. You will always take that price which gives you the greatest advantage. Of course, sometimes it is not merely a matter of money. It may be primarily a matter of convenience. You may pay a slightly higher price for something in your neighborhood rather than take the time to go downtown, where you might get it for a few pesos less. Or you might pay a little more to a person or group you wanted to help, considering the difference a charitable contribution.
3. Man will exchange for a small advantage in preference to not exchanging at all.
These three rules or postulates provide all the answers we need to solve the problems we face in the marketplace. Can you get an advantage? You can. Okay, you exchange. If you can get a greater advantage, you take it in preference to a lesser one, but you will take a small advantage in preference to no advantage at all. You are trying to improve your situation as best you can from your point of view.
Now here are a number of rather simple problems to show how prices evolve and how our value scales contribute to their emergence. Here we are going to assume that you have a use value for several objects you do not own, and that this value scale is:
1st — A
2nd — B
3rd — C
4th — D
Then you learn that you can exchange a "D" for an "A." This is new information, information you did not have when you had this original value scale. This new information changes your value scale and it becomes now:
1st — A
2nd — D
3rd — B
4th — C
5th .….… a second D
A "D" has gone up to second place, not because of its use value but because of its exchange value. You can exchange it for an "A." The fact that you have to take the trouble to exchange it to get the "A" places it below the "A." The second "D" would be valued for the use value of a "D."
So your value scales change as you get new information. You find out that you can buy something cheaper at another place, or you find that something unexpected has happened, or you learn that something new has been invented. You then have a new situation and it calls for a new value scale.
Table 5 presents a slightly more complicated, but still very simple, situation. These problems illustrate the principles that determine how prices are formed and how they are constantly being changed. We start here with an assumption that Smith has four horses. They appear in the first column. In the second column we have his value scales for horses and cows. If he had only four animals he would prefer first a horse, second a cow, third a second horse, and fourth a second cow.
Señor Black, in the third column, has four cows, and his value scale for horses and cows, in the last column, is in this order: first he would like a cow, second a horse, third a second cow, and fourth a second horse.
These two men meet. What happens? One owns four horses. The other owns four cows. When they come together, they soon find out that Smith will gladly trade his fourth horse for a cow. And Black will gladly trade his fourth cow for a horse. They make the exchange. They have both improved their holdings of these two kinds of animals.
In fact, they will go further, in a second step — Step B. Smith will gladly trade his third horse for a second cow, while Black will gladly trade his third cow for a second horse.
|Mr. SMITH||Mr. BLACK|
|1st H||1st H||1st C||1st C|
|2nd H||2nd C||2nd C||2nd H|
|3rd H||3rd H||3rd C||3rd C|
|4th H||4th C||4th C||4th H|
STEP A: Smith will gladly trade 4th horse for a cow.
Black will gladly trade 4th cow for a horse.
STEP B: Smith will gladly trade 3rd horse for a 2nd cow.
Black will gladly trade 3rd cow for a 2nd horse.
STEP C: No further trades of mutual advantage possible.
Then, they both have improved their situations and satisfied their value scales so far as this problem goes. Under these assumptions, no further trades are possible, because there is no advantage to be gained from any other transaction. They have each satisfied their value scales. If their value scales changed, you would have another problem, another situation. So much for that.
Satisfying a Value Scale
Now we go into another more complicated problem, shown in table 6. We assume here that Smith has six horses and Black six cows. In the column on the left we assume that they both have the same value scales. First they would like a horse, second a second horse, third a first cow, fourth a second cow, fifth a third horse, sixth a fourth horse, and down on to the bottom of the column, as you can see.
These two gentlemen come together. What happens? Now looking at these value scales we find that, in the existing situation, Smith has his 1st, 2nd, 5th, 6th, 7th, and 8th preferences, while Black has his 3rd, 4th, 9th, 10th, 11th, and 12th preferences. Under those circumstances, these two gentlemen meet. What happens?
|Mr. Smith (S) has 6 horses (H)|
|Mr. Black (B) has 6 cows (C)|
|1st||1st H||S has his 1st, 2nd, 5th, 6th, 7th and 8th preferences;|
|2nd||2nd H||B has his 3rd, 4th, 9th, 10th, 11th and 12th.|
|Smith trades 6th H for Black's 6th C.|
|5th||3rd H||Then Smith has 5 horses and 1 cow:|
|6th||4th H||his 1st, 2nd, 3rd, 5th, 6th and 7th preferences.|
|Black has 5 cows and 1 horse:|
|7th||5th H||his 1st, 3rd, 4th, 9th, 10th and 11th preferences.|
|8th||6th H||Smith trades 5th H for Black's 5th C.|
|10th||4th C||Then Smith has 4 horses and 2 cows:|
his 1st, 2nd, 3rd, 4th, 5th and 6th preferences.
Black has 4 cows and 2 horses:
his 1st, 2nd, 3rd, 4th, 9th and 10th preferences.
Smith would not gain, so no further trades with this value scale.
If the 5th preference on the value scale were a cow, one more trade would give each his first 6 preferences.
They certainly will be happy to make an exchange. So Smith trades his sixth horse for Black's sixth cow. Then we have a situation in which Smith has five horses and one cow. Now he has advanced his situation to the point that he has his 1st, 2nd, and 3rd (thanks to the trade), as well as his 5th, 6th, and 7th preferences. He has given up his eighth preference to obtain his third preference. He has improved his situation by getting the third item on his value scale in exchange for one that was lower down, in eighth place.
On the other hand, Black now has five cows and one horse. He has gotten his first preference and continues to have his 3rd, 4th, 9th, 10th, and 11th preferences. He has exchanged his 12th preference for his first preference. He, too, has certainly improved his situation from his own point of view.
Under these given conditions, it is also profitable for both of them to make another trade. Smith gladly trades his fifth horse for Black's fifth cow. Then Smith has four horses and two cows. He now has his 1st, 2nd, 3rd, 4th, 5th, and 6th preferences. He has exchanged his 7th preference for his 4th preference. He now has all of his first six preferences. He cannot improve his satisfaction with only six animals.
On the other hand, Black has four cows and two horses. He has his 1st, 2nd, 3rd, 4th, 9th, and 10th preferences. He has exchanged his 11th preference for his 2nd preference. He has his first four preferences, but he does not have his 5th, 6th, 7th, or 8th preferences. He would like to improve his situation further, but in the market you cannot improve your situation, you cannot have a transaction, unless both parties expect to gain. Since Smith could not gain from another trade, there will be no further trades with this value scale. Under these assumptions we have reached the end of the trading.
However, if the 5th or 6th preference on this value scale shifts to a cow, one more trade would give each of them their first six preferences. So this shows that as Value scales change, the possible trades change. Value scales affect everything that can occur in the marketplace. Each person tends to trade up to the point beyond which he cannot gain any more. But he has to find somebody else who will also gain, or there will be no transaction.
We have been talking about barter, the exchange of goods for goods. In a market economy we usually exchange goods for money or vice versa. Now we want to consider exchanges with the use of money, getting into what we call prices. A price can be defined as a quantity of money.
A Böhm-Bawerk Contribution
Much of the material for this lecture has been adapted from the works of Böhm-Bawerk. He was not only one of the greatest economists ever, but he was also a teacher of my great teacher, Mises. Böhm-Bawerk found it useful to compare the formation of prices to the breaking of waves and surf on the sea coast. Both are complex phenomena that seem to be completely "without rule or regularity," yet they are both subject to the strict operation of immutable laws.
When waves break on a rockbound coast, the path every drop of water follows may seem haphazard, but, given the essential data, the laws of physics can explain where every particle goes. Given the force of each wave, given the exact shape and resilience of the coast, and given the velocity and the direction of each gust of wind, there could only be one possible result. The laws of physics could then tell us where every drop of water must fall.
Likewise in economics, if we could know the ever-shifting value scales of every individual, and the available supplies of goods and services in the marketplace, then economic laws, the laws of human action, could tell us where every price would have to fall. Of course, in real life we cannot know the ever-changing value scales of all people. We can find them out in part, but only by reference to market exchanges.
When you go into a store, you do not usually tell the shopkeeper how much you might be willing to pay for a desired good. You try to find out the lowest price for which you can buy it. So when we participate in market transactions we seldom reveal how high we might go for the goods on our value scale. Therefore these values are seldom evident. But value scales determine all actions in the marketplace.
In developing man's understanding of economics, the British classical economists reduced everything to supply and demand. They took supply and demand as given. When they talked about supply and demand, they advocated that the businessman should strive to buy low and sell high. That is good business. But they did not go back to what creates supply and demand. This is a contribution of the Austrian School of economics.
Consumers Determine Prices
As I mentioned in my first lecture, science traces cause and effect by going back and back and back until one cannot go back any further. The Austrian economists demonstrated that you can go back behind supply and demand, and find out what it is that leads to both of them. Demand is determined by the value scales of consumers, while supply is determined by businessmen seeking to foresee, as accurately as they can, the future value scales of consumers. In the end, it is the value scales of consumers that determine both demand and supply and thus the prices of all goods and services sold in the marketplace.
Supply and demand are vague shibboleths that do not provide enough information. The central factor that explains price is found entirely in the subjective values of men. Market competition forces the pricing process into a zone between the subjective values of the border or marginal pairs, where the quantity offered for sale exactly equals the quantity there is a desire to buy at the market price. At that price, supply and demand are bound to be equal. You cannot buy more than are sold, but the price has to be one that benefits all who buy or sell.
Now I'm going to present a few problems using money. You will pardon me if I use dollars here. It makes little difference which monetary unit is used. The first is a case of isolated exchange. (See table 7.) There are just two men involved. Farmer Brown needs a horse. A horse is worth more to him than $300 — that is, he will pay for a horse up to, but not more than, $300. If he has to pay more, it will not be worthwhile for him to buy it. Neighbor Smith has a horse with a use value to him of only $100.
These two men meet. What happens? Naturally it is to the advantage of both of them to make an exchange. We posed the essential questions earlier: whether or not they should exchange, and if so, at what terms. We have determined that these men should exchange. The question then becomes, at what price will the horse be sold.
Given this situation, will they trade? If so, at what terms? Every price from $100 to $300 is possible. The actual price within that range will depend upon the bargaining abilities of the two men. But a price below $100 is impossible. Smith would not sell for less, because the horse is worth that much to him. At a lower price he would use the horse rather than sell it. A price over $300 would not lead to a transaction because the horse is not worth sufficiently more than $300 for Farmer Brown to pay the higher price. So the price must fall between $100 and $300.
There is a rule that applies. It is not my opinion. It is not what I think it should be. It is a fact. It is an economic law. It is how men operate. The rule is that the price must fall between the buyer's subjective value and the seller's subjective value. Any other price is impossible. This seems simple and I hope it is understood. The price must benefit both parties.
Farmer Brown needs a horse. A horse is worth more than $300 to him, but not enough more for him to pay more than $300.
Neighbor Smith has a horse with a use value to him of $100.
Will they trade? If so, at what terms?
Every price between $100 and $300 is possible. The actual price, within that range, will depend on the bargaining abilities of the two men.
RULE: The price must be between the buyer's Subjective Value and the seller's Subjective Value.
One-Sided Competition among Buyers
We move on to a little bit more complicated problem. We take now an example of one-sided competition among buyers. And the question is: Who will buy and within what price range? (See table 8.) Smith has a horse, as before, with a use value to him of $100. As before, a horse is worth more than $300 to Brown. But this time we also have a Mr. Carey for whom a horse is worth just a bit over $200. Who buys Smith's horse? And what will be the price range?
Given this situation, Brown will buy at a price between $200 and $300. Any other price is unthinkable. If the price were below $200, Brown would have competition from Carey. If the price were over $300 the horse would not be worth it to him. So the only sale that can take place, given these assumptions, is between the prices of $200 and $300.
ONE — SIDED COMPETITION AMONG BUYERS
QUESTION: Who will buy and within what price range?
ASSUME: Smith has a horse with a use value to him of $ 100.
A horse is worth just over $300 to Brown.
A horse is worth just over $200 to Carey.
Brown will buy at a price between $200 and $300.
ASSUME FURTHER: A horse is worth more than $260 to Dell.
Brown will buy between $260 and $300.
ASSUME FURTHER: A horse is worth more than $320 to Ely.
Ely will buy at a price between $300 and $320.
RULE: The potential buyer who places the highest value on the good gets it at a price below his own valuation and above the highest value of all his competitors.
Now assume another man, Señor Dell, comes along. He wants to buy a horse, and a horse is worth more than $260 to him. What does this do to the situation? Who will buy the horse, and what price will he pay?
Mr. Brown will buy the horse, but he will have to pay more than $200 under these circumstances. He will have to outbid Mr. Dell. He will have to pay a higher price than $260, but of course he will still not pay more than $300.
Now assume further that another gentleman, Mr. Ely, comes along. For him a horse is worth more than $320. Now what happens? What is the answer to the question of who will buy and within what price range? It should be obvious by now that Mr. Ely will buy the horse. What price will he pay? He has to outbid our friend Mr. Brown. So he will have to pay more than $300, but he will not pay more than $320.
Now, these are not my opinions. This is not how I say it should be. But this is how men act. They try to get what they want at the best price they can, and they do not pay more than the good is worth to them. The rule for this type of exchange is that the potential buyer who places the highest value on the good gets it at a price below his own valuation and above the highest value placed on the good by any of his competitors.
What we are saying is simply that the market allocates scarce goods to those who place the highest values on them, to those prepared to make the greatest sacrifice to attain them. Here we have had competition on one side, competition among multiple buyers for one horse.
One-Sided Competition among Sellers
Now, we move to the very opposite situation, one-sided competition among sellers. (See table 9.) There is one buyer and there are many potential sellers. The question here is, who will sell and within what price range? Potential buyer Brown places a subjective use value of $300 on a horse. Potential seller Fort places a subjective value of $140 on his horse, while Green places a subjective use value of $200 on his, and another potential seller, Mr. Hall, has a subjective use value of $250 for his horse. Who will sell the horse to Mr. Brown, and within what price range?
It should now become obvious that it is not a question of my opinion. Every one of us should come to the same conclusion, because this is a matter of how all men act. It is an application of economic law.
Mr. Brown will buy the horse as cheaply as he can. He will not pay $200 if he can get a horse for less than $200. So, based on these assumptions, he will pay less than Mr. Green is asking. Mr. Fort will sell his horse to Mr. Brown at a price between $140 and $200. Any other price is unthinkable.
Moving on, we assume further that another gentleman, a Mr. Jate, wants to sell a horse. He places a subjective value of $180 on his horse. What does this do to the situation? It reduces the price that Mr. Fort will be able to ask. He will still sell his horse to Mr. Brown. But now it will NOT be between $140 and $200, but, according to his bargaining ability, between $140 and $180.
ONE-SIDED COMPETITION AMONG SELLERS
QUESTION: Who will sell and within what price range?
ASSUME: Potential Buyer Brown places a subjective value (S/V) of $300 on a horse.
Potential Seller Fort with a Subjective Value of $140.
Potential Seller Green with a Subjective Value of $200.
Potential Seller Hall with a Subjective Value of $250.
Fort will sell at a price between $140 and $200.
ASSUME FURTHER: Potential Seller Jate with a S/V of $180.
Fort will sell at a price between $140 and $180.
ASSUME FURTHER: Potential Seller Korn with a S/V of $120.
Korn will sell at a price between $120 and $140.
RULE: The potential seller who places the lowest subjective value on the good sells it at a price above his own valuation and below the lowest subjective value of all his competitors.
We assume another gentleman comes along, a seller, Mr. Korn, who places a subjective use value of $120 on his horse. Applying the same reasoning, Mr. Brown wants a horse, which is worth more than $300 to him, but he still doesn't want to pay any more than he has to. He puts these men into competition bidding against each other. The bidding goes down below the previous high price of $180. Mr. Brown can now buy a horse at a price between $120 and $140.
The rule here is that the potential seller who places the lowest subjective value on the good sells it at a price above his own subjective valuation and below the lowest subjective value placed on the good by any of his competitors. And so a horse moves from the potential seller who places the lowest value on a horse to the man who places the highest value on one. That is how the market works.
These problems have been relatively simple. The value of money is a factor in all of these. This too is not constant. The value of money is always shifting. As the values of horses and money shift, the value scales of people shift. They get different ideas about what is to their advantage. But they only trade when they expect to gain. In these examples we have assumed that their value judgments remain constant until the transactions are completed. The prices that resulted were formed under the impact of the entire quantity of horses on the value scales of all present at the market. All the competing suppliers and buyers had a chance to act to improve their situation according to their value scales as the market conditions permitted. Competition forced every successful buyer and seller to set his price with full regard to the relative subjective values of all concerned.
Now we come to an example of bilateral competition, as I call it. (See table 10.) This is a more complex situation, in which there is competition between both multiple buyers and multiple sellers for a limited quantity of goods, in this case, 13 taxi cabs.
Assumed subjective valuation of similar taxis
|Owners of 13 taxis||Potential Buyers|
Part 1 — How many sold? Within what price range?
Part 2 — Assume (a) sales tax of $50; (b) 10% tax.
In the column on the left-hand side are the owners of 13 taxicabs or taxis. Seven men own these 13 taxis; four of them are owned by Mr. Ace. In the next column we have the assumed subjective values these owners place on their taxis, that is, the figures below which they would not sell the taxis. If they can get a higher price for any one of the taxis than the figure shown in this column, they will sell that cab. On the right-hand side, we have some potential buyers and the highest prices they would pay, the subjective valuations they place on owning a taxicab. If they can get taxicabs for these figures, they will buy. If they cannot, they will not buy.
There are 13 cabs. We shall assume they are identical cabs with no material differences that need to be taken into account. The potential buyers and potential sellers all come together at one time and place. There are potential bidders here, ten, I believe. The questions are: How many of the cabs will be sold? How many will not be sold? And within what price range will the sales be made?
The answer is rather simple. There are many ways you can go about getting it. You can be quite complex and start the bidding low. Of course, no one will offer to sell a taxi for $2,600. If Mr. Dove tries to get, say, $2,700 for his second one, he will have every one of these ten potential buyers bidding for it. They are not going to let it be sold for $2,700. They are going to bid it up. As they bid it up, Mr. Bag comes in when it gets to a price above $2,800. Before then, Mr. Law's demand has dropped out. As the bidding goes higher, other cabs become available, and other potential cab buyers drop out. This goes on until you get into a price range where the number of cabs offered for sale and the number of potential buyers who will buy become equal.
Or you can start with the top. Mr. Ace would be glad to sell his top cab for $4,150 to Mr. Nid. But he is not going to get $4,150 because Mr. Nid is not going to pay $4,150, when all these other cab owners are competing to sell one for less. Competitive bidding will bring the price down, making fewer cars available for sale as it drops below the points in the left-hand column. At the same time, competition will increase the number of the potential buyers as it drops below points in the right-hand column. This will go on until the price reaches the price range where again the number offered for sale equals the number potential buyers will buy.
In this marketplace, we assume all these cabs are similar. There are no known differences, no dents in the fenders as in real life. There will be one price at which the owners will exchange all the cabs that are exchanged. The question is: How many will be exchanged and at what price? The answer is simple.
The best and easiest way to find the answer is to apply what I have already said about the market. This is the fact that the market allocates all scarce goods to those who place the highest values on them. You have 13 taxicabs. You have 23 desires for the taxicabs. Who ends up with the taxicabs? Those who place the 13 highest values on them.
So all you have to do is to find out quickly which are the 13 highest values. The answer to this problem is that six taxicabs will be sold, and the price will be between $3,360 and $3,380. All three methods reach the same result. No other answer or price is thinkable. (See table 11.)
At a lower price, Mr. Ace would not sell his third cab. At a higher price, Mr. Bag would try to sell his second cab. There would be seven potential sellers, but there would not be seven potential buyers. There would thus not be equality between the number offered for sale and the number that would be bought. The bidding would go on until that number was equal, because would-be sellers can never sell more than potential buyers will buy.
So the subjective values of the market participants limit the price range, and the market allocates the scarce taxis to those who place the highest values on them. The 13 who place the highest values on them are those above the line on the left side and those below the line on the right side. When the transactions are completed, these parties are the ones who are going to own cabs. Given this assumed state of the market, the people on the left below the line do not value cabs enough to keep them, while the people on the right above the line do not value cabs enough to buy them.
If there were a 14th cab, one more desire for a cab could be satisfied. If there were 15 cabs, two more desires could be satisfied. But the reality of life on this earth is that there is a scarcity of the things men want, and the economic problem is to decide who gets these scarce goods and who must go without.
Law of Price
In the market economy, this decision as to who gets the limited number of taxicabs, who goes without, and what the price will be, is determined by the Law of Price. The Law of Price is not opinion. It is not what I think it should be. Nor is it a law I would like the government to pass. It describes how men act, in a market situation, each man trying to improve his situation as best he can from his point of view. It is, however, just as immutable as any law of physics.
Under bilateral competition, market prices must fall within a range between upper and lower limits that are determined by the available supply and the subjective values of the interested parties. The upper limit is set by the subjective valuations of the lowest successful bidder and the lowest excluded potential seller, whichever is lower. The lower limit is set by the subjective valuations of the highest successful offerer and the highest excluded potential buyer, whichever is higher.
Prices are determined by the subjective valuations of the two marginal pairs, and must fall within the range between the middle two of these four valuations. Valuations above and below these middle two marginal pair valuations have no effect on the market price.
Now let us look at table 11 again and run through this Law of Price with the figures before us. According to the Law of Price, under bilateral competition, market prices must fall within a range between an upper limit and a lower limit. The upper limit is set by the lower of the pair with the X in the squares. Of those two, the lower one is the $3,380 figure. That is the upper limit.
The lower limit is set by the higher of the pair with the X in the circles. In this case, the higher is the $3,360. So the price has to fall between these middle two, $3,360 and $3,380.
At any other price, there would not be equal numbers willing to buy and willing to sell. This is not my opinion. It is how all men act. They will not buy unless they expect to improve their situation by getting something they value higher than they value the sum of money they pay for it. They will not sell unless they value the money received higher than they value the good they offer for sale. Every participant expects to gain from every transaction, and there must be a buyer for each unit sold. Likewise, men will not pay more than market conditions demand; nor will they sell for less than competitive market conditions compel potential buyers to pay.
Effect of Taxes
Now we shall try to show what happens when the government places a tax on the transaction. First we shall assume a sales tax of $50 on every sale of a taxicab. That means you have to add $50 to the subjective value each potential seller places on his taxicab. He will have to get at least that much before he improves his situation by selling. What happens with this problem?
Under the assumed conditions, only five cabs would be sold, and the price would be in the range from $3,350 to $3,360. With the tax included, this price range would be from $3,400 to $3,410. (See table 12.)
(Second part of problem answered)
Effect of Taxes
Assume sales tax added to sales price of each taxi in table 11.
|If a flat rate of $50 per taxi:||If a 10% sales tax rate:|
5 taxis will be sold at a
4 taxis will be sold at
If the tax were 10 percent of the sales price, only four cabs would be sold, and the price range, with the tax included, would be between $3,575 and $3,663.
Now we have seen what would happen to the price. It goes up. We have also seen what would happen to the number of transactions. Fewer cabs are sold. This means that under the first assumption, the $50 tax, one taxicab has to remain with a man who places a lower value on it than another man, a potential buyer, does. Because of the tax, the taxicab cannot be transferred to the potential buyer who places a higher value on it, but for whom it is not worth the extra $50 he must now pay.
When the tax goes up as high as 10 percent of the sales price, two taxicabs have to remain with men who place a lower value on them than would be the case in a market where the taxes did not exist. So sales taxes stand in the way of transactions that would increase the satisfactions of both potential buyers and potential sellers.
Of course, those taxes might be necessary for the market to operate. In that case they are a necessary cost of doing business. But when they are just an interference with the market, or a tax to provide a subsidy for some privileged group, rather than an expense for the equal protection of all, they must diminish the satisfactions of the people operating in the marketplace. Every transaction prevented reduces the satisfaction of a potential buyer and a potential seller. In addition, it results in a rearrangement of market conditions in a manner that must reduce the highest potential satisfaction of human beings.
This is how prices come about. They emerge from the concatenation of the subjective values of all the people participating in the marketplace, each one trying to improve his situation as best he can from his own point of view. Except for the valuations of the middle marginal pair, changes in the valuations of the other parties have no influence, as long as they do not cross the price range of the middle marginal pair. If one of the potential buyers below the line was willing to pay up to $10,000 for a cab, it would have absolutely no influence on this particular situation, because he will not in fact pay more than he needs to pay, that is, the market price.
Remember that price must benefit all who trade. You do not trade unless you expect to benefit. Price must also allocate the available units to those who place the highest value on them. And every interference with free-market prices is an interference that must diminish the human satisfaction of moral persons. It leaves things where they are worth less than they would have been worth if the market had been free to transfer them to those placing the highest value on them.
The same is true of laws that do not directly affect price, but do directly affect what you can trade, the hours during which you can trade, or where you can trade. All such laws reduce transactions and must therefore reduce human satisfactions.
We have been talking about consumers' goods, or things that people seek for their own use satisfactions. Let us go into the more complicated part of the market — producers' goods, or goods that are eventually used to make consumers' goods. When valuing producers' or capital goods, men transfer values of consumers' goods to their factors of production, that is, to the various things that are needed to make the consumer goods. It is thus the market value of consumers' goods that determines the value of labor, machines, and raw materials. For this, economic calculation is necessary.
Under socialism, economic calculation is not possible. Without a market, socialists cannot calculate what goods will give the most satisfaction, or the most efficient way to make whatever they decide to make. Since the government owns and controls all the factors of production, there can be no competitive market bidding for scarce materials to decide how they should be allocated. This is a function of prices in a market economy. But there is no market for raw materials or other factors of production in a socialist or communist society.
In a socialist or communist society, those who want to find out whether steel is more expensive than aluminum or some other metal have to buy a newspaper from a country that has a market. Even then, the prices in that paper will reflect the relative values of that country's market and not those within the borders of the socialist area, where supply and demand conditions may be very different. Socialists have no other way of knowing relative values. They must rely on the opinion of some bureaucrat, someone with authority. Without competitive prices, planning production is like trying to solve a puzzle without an answer. Because it monopolizes raw materials, the government receives no help from competitors in determining relative values.
In our market calculations we grade, prefer, and set aside. Values are ordinal and comparative. Now let's take an example of what happens in the market with one of the factors of production. Take iron, for example.
The price of iron originates in the businessmen's appraisal of the consumers' subjective valuations of iron products, products of which iron is a part. After all, businessmen cannot sell their products unless consumers consider them a bargain. So their ideas of consumers' valuations determine how high they will go in bidding for iron and the other factors needed to make their product.
The available supply of iron, like that of taxicabs, always goes to the highest bidders, those who expect their use of the iron will bring the highest price from consumers. Of course, the larger the quantity offered for sale, the fewer the potential buyers who are disappointed. Money is the common denominator for calculating the most profitable uses of the limited supply, that is, the best-paid uses, the highest prices on the market.
The available iron is sold to the highest bidders, with the marginal buyer determining its price and thus the cost to all buyers, even those who might have been willing to pay more. The competition of sellers drives prices down on all iron products. If there are high profits, there will soon be more suppliers competing. General market bidding thus allocates all the available supplies of all factors of production so as to satisfy the highest not yet satisfied consumer wants. High market prices for a product induce businessmen to increase production of that product, while low market prices cause businessmen to use the factors of production to make other consumers' goods for which they expect prices to be higher.
Market Effect of Savings
Whenever additional savings are available, these new savings start a bidding for the factors of production needed to supply the highest not yet satisfied wants on consumers' value scales. This bidding raises costs, including wages, and ultimately results in more production, which tends to lower prices and squeeze or eliminate profits.
If the cost of some factor of production is too high for businessmen, it means there is another use for it for which consumers are expected to pay a higher price. Prices are expressions of relative scarcity in relation to demand. Values are not quantities but arrangements in order of importance in satisfying human wants. Adding values, like adding love, is crazy. We can only compare them.
As consumers' value scales change, the kinds of wealth produced must change. Market prices are the indicators that direct businessmen to change their production. Businessmen tend to produce units of every article up to the point at which they expect consumers to pay all costs of production, including interest. A profitable industry tends to expand to that point; an unprofitable one tends to shrink to that point. Thus consumers, by their buying or non-buying at or above the cost of production, determine how much should be produced in every branch of industry.
There prevails upon the unhampered market a tendency for consumers to encourage production in every industry up to that point at which the marginal producer or producers make neither a profit nor a loss. Flexible market prices are the means for revealing that point to producers. Any outside interference with freely flexible prices must misdirect production and lead to diminished satisfaction of consumers.
Subjective Values Determine Prices
As stated in the beginning, it is the subjective values of individuals which allocate the available supply of every good, so as to satisfy human wants in the descending order of their importance, whereby the particular want last satisfied is the one with the marginal utility. From beginning to end, prices, and thus economic calculations, are the products of subjective valuations. They are the results of the reciprocal impact of the subjective values placed on the goods and those placed on a quantity of money by all interested parties. Every price must benefit all who exchange.
There is nothing automatic or mysterious in the operation of the market. The only forces determining the continually fluctuating up-and-down state of the market are the value judgments of interested individuals, and their actions as directed by their value judgments. The ultimate factor in the market is the striving of each man to satisfy his needs and wants in the most economical way possible or known to him. The supremacy of the market is in fact a supremacy of the consumers. Interfering with the market interferes with the satisfactions of consumers.
QUESTIONS AND ANSWERS
Effect of Consumers' Values on Producers
Q. What you have explained is all right for products which already exist. But does it apply to those that don't exist — to new ones?
A. Certainly it does! As I have said, people's wants are never fully satisfied. There are always some things they want that they do not have. When there are new savings in a market society, the saver becomes an investor. He tries to invest his savings in a way that will produce more goods. What goods? Those goods next lower on consumers' value scales, for which their needs have not yet been satisfied. These are the goods that businessmen expect consumers will pay more for in the future than their current cost of production. When he produces these new goods, he has got to bid for labor. He has got to bid for raw materials. Thus he pushes those wages and prices up to take the labor and raw materials away from other uses. Then he produces goods that have to be sold in competition with all existing goods. With more goods and no change in the quantity of money, prices are lower than they would have been, and everyone gets more for his own limited amounts of money. To answer the question more specifically, every businessman must pay attention to consumers' values — to what consumers want and will pay. This may mean producing larger quantities of presently available goods or entirely new items not previously available. In either case, more human wants are satisfied. If a businessman does not pay attention to consumers' wants, he will soon be out of business.
Morality of Speculation
Q. The majority of people consider speculation immoral. What do you have to say about that?
A. Calling speculation "immoral" is saying that all men are immoral, because we are all speculators. It is even a speculation to cross the streets in Buenos Aires — or New York. No one knows the future. We have to speculate. All of our choices and actions are speculations.
It is true that many consider immoral those "terrible" people who make money speculating. Do you know that you cannot make money speculating unless you serve society? If you speculate on the future and do not serve society, you lose. The normal process for successful speculation is to buy something cheap at one period and sell it high at a later period. Speculators make a profit when they can do this. But when they buy, they have no assurance that it is going to be higher later. It could be lower and then they lose. Try it in the stock market sometime and you will find out.
If the speculators buy something when its price is low, they are buying it when it is in relatively large supply and, because the price is low, people are using it as a cheap good. If they sell it later at a higher price, it is because it is then scarcer in relation to the demand for it. It is, therefore, worth more and serves human uses that are more valuable. So what the speculator does to earn his money is to buy the good when it is cheap and store it for when he hopes it may be more expensive. If this is something that is needed for life, like the grain in the story of Joseph in the Bible, when the seven plenteous years were followed by seven years of famine, the service to society becomes evident. Those who save goods when there is a plentiful supply and make it available when there is a famine, or no other supply, are speculators who make money by serving society. If, on the other hand, there is, later on, a larger supply, the speculator has to sell his stored supply at a cheaper price, pay for the warehouse, pay interest on his investment, and thus he loses. A speculator can make money only when he serves society. A speculator is a person who tries to foresee the future situation and prepare for it. Only if he sees and acts relatively more effectively than other people in satisfying human wants, does he make a market profit from his speculation. Serving society is never immoral.
On Effects of Intrinsic Value and Quality
Q. What do you have to say about the influence of intrinsic value? And about the influence of quality?
A. Those are really two different questions. In economics, there is no such thing as intrinsic value. This is a very common error, particularly concerning the precious metals, including gold. Nothing has value in the market unless it satisfies some human want or need. The value of something is in a person's mind. It is not in the product. Of course, the physical qualities of a good contribute to its usefulness to men. However, it is only when men can see a use for a scarce good that it has value.
Now, of course, the quality of a good is an essence of its value. Rotten eggs have little value. There are people who will pay more for a higher quality. But the seller can charge a higher price for a higher quality only if people want the higher quality. Most of us, of course, prefer higher quality. We do not go around in rags. We buy suits that are made to fit us. We buy suits that look better on us than simple lengths of cloth that we could wind around us to keep us warm, and we pay more for them. It is the consumers who determine both the values and the qualities that are found in the market.
Competition and Monopoly
Q. What happens to the Golden Rule when there is no perfect competition, that is to say, under oligopoly and monopoly?
A. First, about this "perfect competition," we could spend a whole evening on the fallacies embraced by that idea. There is no such thing as perfect competition. But in a market society there is always competition. In one sense everything in the market is in competition with everything else for the consumers' dollars.
We could spend another couple of evenings on the question of competition and monopoly. Actually, the only monopolies we have to fear are those that are monopolies because they have a special privilege from a government. If there is freedom to compete in the marketplace, you can maintain a monopoly only as long as you are superior to every prospective competitor. In a free-market society, you do not have a monopoly unless you are doing something better than any other person or group of persons could do it.
In one sense, we are all monopolists. We each have a monopoly on our own services. The man who is the best prize fighter, the champion of the world, has a monopoly on that title. The opera singer who can sing the highest note has a monopoly and gets the highest price. The man who owns the only gasoline station in a community has a monopoly. In a free-market society, if anyone can do better, he is free to compete.
The problems of monopoly get down to the question of monopoly prices. No one has to pay a monopoly price unless he is satisfied that doing so improves his situation. In a free market anyone should be able to compete, if he thinks he can compete.
Most of our monopoly problems come from special privileges granted by law. The answer there is always to take away the special privilege. With equality before the law, which was mentioned in one question following the first lecture, there is no significant monopoly problem. Everybody should have an equal right to compete. Then those who give consumers the greatest satisfaction will be the ones who succeed. If they get fat, lazy, and rich from their success, then somebody else will come along, compete, and knock them down. In a free market, newcomers are constantly trying to replace the giant firms on the top.
One of the worst effects of the New Deal in my country and of welfare state processes in other countries is that they keep at the top those who are already there. Interventionism tends to protect them from the competition of those at the bottom who would like to replace them.
For example, it is now impossible in my country to do what Henry Ford did forty years ago. What Henry Ford did was to employ men to make more automobiles for more people, who bought them all at prices that they considered bargains. He paid the workers higher wages than they could get anywhere else. He made these automobiles for the masses and became rich. What did he do with his wealth? He plowed it back into more or bigger factories, hiring still more men to make still more cars.
Today, with present tax rates, the government takes a good part of all profits, including more than half of the profits made by corporations. As a result a businessman in the United States can no longer expand as fast as Henry Ford could. He therefore cannot compete as easily against the giants already at the top. So these laws, supposedly directed against the top people, are more against the new, smaller, struggling competitors. They prevent newcomers from competing with those already on the top as efficiently as they could if they were permitted to keep and plow back into the business more of their early profits.
Calculation under Communism
Q. Considering the actual value scales existing in Communist Russia, must not the Communists calculate economic values on the basis of the cost of production?
A. They have no cost of production, or rather, their cost of production is the sweat and blood of their people. It is an order: You do this, or you do that, or you do something else. They cannot calculate market costs because they have no market to tell them costs. Their calculations have to be based on the judgments of a czar, the czar of each particular industry.
Some ten years ago, I put together an article that was largely quotations from Russian papers, Pravda and others. It related several interesting incidents, which indicated that these papers were not entirely happy with the operation of their own Russian Soviet system. It seems there was one industry that had to move goods from the north to the south on the Volga River. So they built a fleet of boats to move these goods from the north to the south, and the boats returned north empty. There was also another industry that had to move goods from the south to the north. So this industry built another fleet of boats that returned south empty.
Now in a market economy, there would be common carriers, or advertising that would bring the two industries together. In either case, the market economy would not waste its scarce labor and its scarce materials by building two fleets of ships to do what one could do.
Another interesting article was about the Soviet railroad organization. It was paid to carry things on the railroads. The railroads had some tank cars. If they moved oil in one direction, they got paid for it. If they came back empty, they did not get paid for it. So on the return trips they would fill up the tank cars with water. That way they got paid for the return trip. How can you calculate costs under such a system? There are many examples of such uneconomic actions. I shall cite one in a later talk. It concerns a trade agreement arranged between East Germany and the Soviet Union that resulted in a suicide.
The communists have no means of calculation unless they look outside the country to market economies. Then they have the relationship of supply and demand that exists within the other country. The communist system, because it has no economic calculation, has to be inefficient. Communists can never be forerunners. They must always be followers. When people understand this, they will no longer be afraid of them as an economic power. If communism were a good and strong economic system, we should adopt it. But the communists are not strong. They are weak. They are now trying to copy capitalistic production methods, but they cannot do so while the government controls and allocates all the factors of production. Without markets, they are blind as to real costs.
Christianity and Capitalism
Q. Do you think that Protestantism has helped free-market principles?
A. Well, I am a very staunch believer that free-market principles are in full harmony with Christian principles and that the free market is the only economic system that is consistent with Christian or Judeo-Christian principles. I must say that in recent years the organized churches, both the Protestant and the Roman Catholic, have not been in harmony with free-market teachings, nor have they been in harmony with what I must hold are the principles taught in the Bible. The organized churches have largely accepted the welfare state ideology so popular today. This ideology has changed the original meaning of the Ten Commandments. I could give you quite a speech on that. However, I want to make just this one point. There is the Commandment which in English is only four words: "Thou shalt not steal." Today, most of our people think that it has been expanded to eight words. They think it is: "Thou shalt not steal except by majority vote." They seem to think that any stealing done by majority vote is all right.
Except when necessary for defense, neither capitalism nor Christianity approves of the use of force or coercion. The fundamental principle of the free market, voluntary social cooperation for mutual advantage, is in full conformity with Judeo-Christian teachings.
Antitrust Law Interventions
Q. What do you think about the antitrust laws?
A. How many weeks can we have to answer that? Antitrust laws are like all other interventions. They help certain interests and they hurt others. They always hurt the consumers. In my country the antitrust laws originated because the government had given privileges to certain industries, and the companies, particularly the railroads, used these privileges to enrich themselves at the expense of the consumers. By law, the railroads were handed monopoly privileges that protected them from competition. Once they had this monopoly, they raised rates above those that would have attracted competition; but no competitor could come in to lower them. Then the people and the government said, "We have to control these greedy monopolies!" This led to the creation of the so-called antitrust laws.
Most of the antitrust laws are aimed at trying to undo the damage created by earlier government laws. I have written an article on this subject, particularly with relation to labor unions. It is entitled, "Is Further Intervention a Cure for Prior Intervention?"1 My answer is "No." Marx wanted such interventions because, as he correctly stated in the Communist Manifesto, they will make matters worse, create a demand for more and more intervention, until they result in overturning the capitalistic system. This is what is happening in many countries today. When people think the remedy for anything they do not like is another law, you get more and more laws until there is no freedom left. Every one of these governmental interventions makes matters worse from the point of view of those who advocate them. Try and think of one that does not.
Are High Prices Helpful?
Q. Do you think that the producer who sells his product at high prices benefits the community?
A. Yes, if he can get them. If the high prices mean a high profit, he is soon going to have competitors who will gradually bring the price down pretty close to the actual costs of production. Let me cite an example that has been before the world just recently, the case of the few doctors who are able to transplant human hearts. Suppose you only allowed them to charge $100 per operation, and they could only perform one operation a week, and there was need for many more. Who would be selected, and how many young doctors would train to learn that operation, if $ 100 once a week were all they could make? On the other hand, if they were allowed to charge the highest price they could get, the market would select their customers. If that price were really high, many young doctors would want to learn to perform that very intricate operation. In a short period of time, more doctors would be able to perform the operation; the price would come down and more people could benefit from that type of operation, if it could help them.
The remedy for high prices is prices high enough to attract competition. When you lower prices by law, you not only fail to attract new producers, but you also make it unprofitable for marginal producers to continue in business. So production goes down, and consumers are provided with less satisfaction.
We have seen that in my country in connection with the question of rent control. During World War II, they said we had to take care of the poor people and keep rents low. So they froze rents then in effect across the nation. Wartime inflation raised the costs of construction. What happened? Nobody built any houses for rent, not even after the war, when construction materials were again available for peacetime uses. Did that help the boys who came back from the war, married, and started new families? No. It only created a still greater shortage of rental housing.
What was the political solution? Another law — public housing. First, there was public housing for politically selected low-income families. Now it is public housing for politically selected middle-income families. Like the public schools a century earlier, it may be public housing for all incomes before long. In Russia, you take the housing the government assigns you. In Sweden, married couples sign up for space on a waiting list. By the time they get something they are ready for divorce.
On Politics and Poverty
Q. How do you explain the fact that today, although we live in a free-market economy, every day there are fewer rich and every day more and more poor?
A. I do not know where the questioner lives! In my country and other countries of the Western civilization, we have had more and more wealth under relatively free-market economies. It is only where government intervention results in capital consumption that there is less wealth produced. Marx certainly never envisioned the automobiles you have running around the streets here. He thought that before the end of the 19th century people were going to be starving, and that then they would rise up, throw off their chains, and create a dictatorship of the proletariat.
Now the automobiles that you have in Buenos Aires are not for the rich only. Those who are really poor today are poor largely because government intervention keeps them from competing for jobs. I, of course, am no authority on your economy, but I do know that in my country the poor, and particularly the Negroes, are kept poor because the labor unions can legally keep them out of jobs. We shall be saying more on this subject in the next lecture. It is the interventionist laws that prevent the poor from getting on the bottom rung of the ladder so that they can start the climb up. The stress of poverty is greatest when production goes down, and this usually occurs as a result of government interferences with a market economy.
We may not have a free-market economy but we do have a market economy. We have what my great teacher calls a hampered market economy. It is hampered. Its operations are hindered by governmental interferences. Under this situation we all have less. Both the rich and the poor have less, but the poor suffer more. The rich can get along comfortably with a little less, but many of the poor cannot take that less. Most government intervention is intended to help the poor at the expense of the rich, but, short of a dictatorship, it is always at the expense of everyone, including the poor.
Speculators and Scarcity
Q. Do you agree that a speculator can artificially create scarcity so as to sell at a high price?
A. No, I would not agree that he can artificially create scarcity except in a very, very temporary local situation. We had a case in New York. Some of you may remember that a couple of years ago our electricity went off late one afternoon, and remained off for some 15 hours. People were caught in elevators. Everything was dark. Radios and TVs were silent. No one knew why. The only news I could hear was the radio in my automobile, and the local stations were going off the air. All of our electricity had gone off. There was a scarcity of electricity, to put it mildly. Those people who had flashlights and candles to sell were in a position to make a nice little profit. But if those flashlights and candles had not been there, the people could not have had them. People can make these profits only when they foresee the future better than their competitors. In a free society everybody has the right to be a speculator. If you think the price of cotton is going to double by next year, buy it now. Sell it next year. You have as much right to do it as anybody else. But what if you do, and the price goes down? This is the chance the speculator takes. If someone destroys his own property to raise prices, he is going to invite competition, so that any gain will be short-lived.
Q. What are the consequences of imposing maximum and minimum prices?
A. Imposing a maximum price — that is, holding prices below those of the market — means that the marginal producer will not cover his costs and will go out of business. Imposing a minimum price — that is, holding prices above those of the market — has the opposite effect. It means that more will be produced than can be sold at the minimum price.
Mises tells the story of how they like to introduce these maximum prices by putting them on something that is very much needed, say milk for babies. The poor people need cheap milk. So we lower the price of milk by law. And what do the people who have the cows do? They use the milk to make cheese and ice cream, which are not under price control. So to keep the price of milk down you have to apply the price controls to cheese and ice cream. The controls then must be applied to the expenses of the dairy industry, and eventually from one product to another, until you get to the point that Hitler reached in Nazi Germany.
Establishing minimum prices, by which the government guarantees a higher-than-free-market minimum price to producers, as we have done in our farm programs in my country, means that you soon have surpluses piling up in warehouses. The taxpayers then have to pay subsidies to the farmers, storage, and higher interest charges, as well as higher prices for their food and cotton goods. In fact, all over the world new areas are now growing cotton and taking our former markets away from us. The free market would direct those now producing the surpluses to make something else that consumers prefer rather than more of the goods for which prices are held artificially high.
The maximum prices reduce production and the availability of the goods. The minimum prices increase production beyond what people want at prices that cover the marginal cost of production. Then the product has to be warehoused or destroyed. In your neighboring country, Brazil, they simply burned their surpluses of coffee.
Existence of a Free-Market Economy
Q. In the United States, do you have a free-market economy, and if so, tell us since when?
A. The free-market economy is like Christianity. It is a goal to move toward but human beings never quite attain it. We have never had a completely free economy in the United States. It was only relatively freer than any that had ever existed in the world before. It protected private property and brought us great capital accumulation, on which we are now living. The nearer you approach to the free-market economy, the higher the standard of living will be.
Product Durability vs. Higher Sales
Q. Would you be so kind as to discuss briefly the soundness of a policy of manufacturing goods that do not last too long, thus insuring a continuing demand, creating manufacturing volume, and thereby reducing both costs and selling prices?
A. Well, a manufacturer's purpose is, of course, to maximize his profits. He has to compete with businessmen who may have different ideas of production. It is always the consumers who will decide which manufacturer gets the profits. I am the son of a Britisher and this question led to debates I used to have with my father about automobiles. As a Britisher, he defended the Rolls Royce, which did not change its models every year, had higher quality, and lasted almost a lifetime. In the United States, we change our automobile models almost every year in some way. The consumers then decide which of the two they will buy, the one that will wear out quickly, or the one that lasts a longer time.
The same thing is true of styles. In my country, as in other countries, the women's wear industry has persuaded women to change their styles almost every year so the industry will have more sales. They are now trying to do it with the men. Clothing manufacturers would like us to throw our clothes away because they are out of style rather than because they are worn out. Any business can attempt this, but the final decision is always made by the consumers as they spend their money. So in the long run, the manufacturer has no choice; he must provide what the consumers will buy.
Right to Destroy Wealth
Q. Has the producer the right to destroy the products he produces?
A. The question is: Does he own them? If he has paid for them, he has the right to do that; and I suppose he has the right to commit suicide too. If you have something of value and want to destroy it without harming anyone else, that is your right. But if it has a market value, there is no inducement to destroy it.
- 1. First published in On Freedom and Free Enterprise: Essays in Honor of Ludwig von Mises, ed. by Mary Sennholz. (Princeton, New Jersey, D. Van Nostrand Co., Inc., 1956. Reprinted separately by the Foundation for Economic Education, Inc., Irvington-on-Hudson, N.Y.).