SimpleDon
Veteran Member
Well... I can't speak for what Loren Pechtel has said, since I believe I've disagreed with some of his positions. But I will answer on my own behalf.SimpDon said:So you both are saying that the supply and demand mechanism sets prices, except when it doesn't.
The obvious question then is how many prices in the economy are set by the supply and demand mechanism and how many are set by other price setting mechanisms?
It would seem to me that there is a big difference between there being 80% supply and demand set prices and only 20% supply and demand set prices in how the economy reacts to something like an increase in the minimum wage. Wouldn't you agree?
Of course, I don't expect you to speak for Loren. I wouldn't presume that anyone could speak for Loren. As I read it Loren has now agreed with you that a supplier can operate indefinitely at a price that equals their costs, they don't need to earn a profit. [/presuming to speak for Loren]
The model is not perfect. For the most part, prices are set by supply and demand. The minimum price is defined by the cost or production. What this means is that if supply and demand produce and aggregate price that is below the cost of production, then you go out of business. You can't stay in business if you can't recoup your costs. So if you want to be in business, then supply & demand have to produce a price that at least meets your floor - your cost of production.
Profit is the excess of price over that floor. When price is above the cost of production, then the excess is profit.
There's always a bit of a balancing act: You can sell fewer items at a higher price or you can sell more items at a lower price. This is because each individual consumer is going to have a different and unique budget line and indifference curve. The lower a price the seller is willing to accept, the more consumers whose indifference curve they'll meet and whose budget line they'll fall below.
So the seller has to work toward optimizing their revenue: what's the optimal price? What price will get them the highest net profit? That's usually where they try to set their price.
But it's all pretty much supply and demand at play.
The exceptions come in when you've got regulated businesses where some outside entity is setting prices (for example, where the government has oversight on the price of health insurance) or where the seller is a monopoly and can charge whatever they want, or where there is a coercive effect at play (as with some prescription drugs, where you pay the price regardless, or you die).
All the rest of the things that Loren and I have mentioned - concepts around brand and the fungibility of your product, those are all manipulations of supply and demand. So at the end of the day, they're still supply and demand .
This is kind of back to the supply and demand sets prices except when they don't construction, supply and demand with fudging like "that's usually where they try to set their price" and "You can sell fewer items at a higher price or you can sell more items at a lower price." But you do realize that supply and demand don't determine the price completely. This puts you ahead of quite a number here. And you are right that the producer can't stay in business with long term losses.
You believe that supply and demand set the price but that average (not marginal) costs provide some hazy, long term limit to how low they can go and the producer stay in business. You have the right idea, it is just that you have it reversed, almost all prices are set by the supplier at average cost plus an anticipated profit and supply and demand are the hazy, long term limits to the success or failure of the business.
I believe that explanations like yours are the result of trying to reconcile what people know of the pricing process from their own experience with the supply and demand theory that they learned in freshman economics and is recited repeatedly in public. In this case, you would be better off going with your experience
You have to understand a few things about economics in the US. A dreaded list for the sake of brevity. I am willing to expand on any of them as needed, but you probably already knew that.
- Economics education in the US teaches only a narrow band of the economic thought that exists in the world today.
- This narrow band is almost completely focused on the idea that we should change our current economy into the economy of the free market.
- This is pretty much a response to the fact that it is this line of research that attracts funding, from wealthy people and corporations.
- Economists in the US are almost entirely microeconomists, those concerned with the operation of the economy on the level of the individual or a single company.
- Few economists in the US are macroeconomists, concerned with operation of the economy as a whole, on the national level, which is what we are talking about here.
- Economics educators do most of their students a grave injustice, they teach concepts that they know are simple fairy tales that are seriously in question.
- They justify this as being needed to get students 'thinking like economists' in the face of the fact that their students don't have the math skills required to understand the real economics.
- This problem is not just limited to the non-economics majors, to a large degree it also applies to the economics majors who don't go to graduate school.
Enough trashing of economists. Let's look instead to compare their fantasy economy to the current economy as it exists. Once again, a list of the bullet points only,
- The mixed mode, public/private partnership, government policed economy that we have today is the result of centuries of evolution and growth, of trying new things, throwing away those that didn't work and keeping and improving those that did work.
- The economy that we have today is the result of these free choices that the market made, not the result of heavy handed governments wanting to control everything.
- The market decided that they didn't want were prices that varied day by day or month by month.
- The most radical of the free market enthusiasts claim that government interference in the market prevents the prices from providing investors with the information that they need to decide whether or not to invest.
- What investors want is stable prices (and costs) that change slowly and above all else predictably so that they can calculate the probability of making a profit.
- Supply and demand setting prices directly and immediately doesn't provide this stability.
- The modern market is one of price offerers, the producers and retail, and price takers, the consumers, rather than the price haggling bazaar of the free market fantasy.
- As you know the producer bases his price on three things, his average costs, his projected sales volume and the total amount of profits he needs/wants to satisfy his investors.
- He puts the product in the market, offered at his price. If he gets his sales volume at his price he is happy.
- But if he doesn't he has a lot of choices, he can try to brand his product, to increase its perceived value ala Nike, by advertising and promotion.
- He can call his engineers and designers and improve his product or his production efficiency.
- The last thing that he wants to do is to lower his price, because now to get the profit that he needs/wants he has to produce and sell more of his product than he originally planned to.
- The important point is that his goal is to maximize his profits.
- If he was in the fantasy free market economy he would have to take whatever profits that supply and demand allowed him.
- The goal of the fantasy is to prevent all of the producers from maximizing their profits by forcing the price down to its market clearing price, the price that squeezes the production capacity by putting the less efficient suppliers out of business and utilizes all of the available production capacity of the surviving, more efficient producers.
- The promise of the self-regulating free market with prices set by supply and demand is the maximum efficiency of production in the economy, not the maximum profits for the producers.
- The fantasy free market self-regulates when this market clearing price equals the marginal cost of producing the last item produced.
- This has an unfortunate side effect in a largely industrialized economy, it means that there is no profit.
- This is not good, the driving force of capitalism is profit.
I suspect that this is one of the reasons that the market has collectively decided not to embrace the self-regulating free market. But that might just be me.
Do have to tell you that I have been told repeatedly that the free market doesn't need market clearing prices equal to the producer's marginal product in order to self-regulate. I have asked the obvious next question of how then does the free market self-regulate?
There doesn't seem to be any definitive answer yet but I have been assured that the neoclassical economists who are apparently in charge of "free market apologetics" are working on it. The current thinking is along the lines of an expansion of Milton Friedman's "as if" principle, that economic theories don't have to reflect reality as long as the economic actors believe in the theories the economy will behave as if the theories were correct. Neoclassical economists are not big on falsifiability as a principle, obviously.
If you are a member of the free market cult this what you are what you are hanging your intellectual hat on. It is pretty much bullsh*t form beginning to end. Enjoy.