Tuesday, February 26, 2019

Price Dynamics: Two Vignettes

     It takes actual real-world experience at making at selling things to become aware of the influences that actually guide product pricing. As I’ve already written, the costs of production are insignificant contributors to such matters. Governmental intrusions can play a part, of course, as can other factors not under the control of the maker / seller of the product. But in a truly free market, the price of good X will fluctuate according to those two old devils:

  1. Supply: The amount of X available within the acceptance horizon of RWA purchasers;
  2. Demand: The number of RWA purchasers.

     Above and henceforward, RWA shall stand for:

  1. Ready: The purchaser is ready to transact on current terms;
  2. Willing: The purchaser is willing to meet the seller’s current terms;
  3. Able: The purchaser is able to meet the seller’s current terms.

     The sole mysterious phrase in any of the above is acceptance horizon. That’s the length of the interval between two points in time:

  1. Tcommitment: The point in time at which the purchaser and seller agree to transact;
  2. Tacquisition: The point in time at which the purchaser acquires what he purchased at Tcommitment.

     The seller has a veto power over the price he will accept. However, the purchaser determines his acceptance horizon. The seller may attempt to influence it, as for example in the case of a car to be built to a custom order, but the last word belongs to the purchaser.

     Even if the terminology looks a little abstruse, this is essentially simple stuff: Beginning Economics for the Uninitiated. The underlying phenomena are about property: specifically, the rights that a property owner will possess and exercise in the absence of coercion. Among those rights, the most important one is the owner’s right and power to exclude others from using or making off with his property. It’s the attribute that distinguishes goods that can be owned from public goods, which lack it.

     As time passes, every aspect of the various factors mentioned above will fluctuate, and so also will the supply, demand, and price of good X in actual transactions. The classical supply-demand equilibration graph suggests that as the supply of a good increases, the price it commands will decrease. However, if the good proves to be in substantially greater demand than the maker / seller originally expected, the price of that good will rise rather than fall even if the supply of the good increases concomitantly. Our first vignette addresses this phenomenon.

     Yet at no time does the cost of production of a unit of X, however it might be determined, do more than discourage the maker / seller from lowering his price “too far.” I must emphasize this point: To discourage further production for sale is all the cost of production can do. Our second vignette addresses this factor.

     Thorstein Veblen, a “dissenting” thinker of the early 20th Century, attempted to shoot holes in classical economics by asserting that it makes claims that don’t hold up. For example, he lampooned the supply-demand equilibration dynamic by showing that even though the supply of a particular luxury automobile had increased steadily over a period of months, its price was rising as well. That, he claimed, was enough to refute classical microeconomic theory.

     Veblen’s contention fails in two ways. First, he neglected to extrapolate his own assertion, specifically thus: Could the price of the popular auto continue to increase indefinitely? The answer is plainly no; over time the market would saturate and the price would fall to a holding level. The second fault in his argument is that he was shooting at a straw man: classical economics doesn’t insist that as supply rises price must fall. Indeed, the dynamic nature of demand – i.e., the number of RWA purchasers at any given instant – makes such a notion ludicrous on its face. The demand for a good can increase because of factors completely disconnected from its supply: publicity, fads and fashions, or a rapid increase in general prosperity are only a few.

     Veblen, an early “progressive” socialist who disliked the very idea of profit, could not cope with this refutation of his thesis. He attacked personally those who pointed it out to him, most notably H. L. Mencken, who never saw an overinflated ego he would not immediately strive to puncture.

     In the late Seventies and early Eighties, with the microcomputer revolution just gathering steam, a number of companies that were “late to the party” attempted to enter it by introducing computers that mimicked the more successful existing manufacturers. Unless you were part of the scene back then, you probably won’t remember North Star Computers, the most successful of the CP/M-80- based machines of that time. I worked for a “late to the party” company which produced the Multivision, a computer broadly modeled on North Star’s offering.

     There was nothing wrong with Multivision. It was an example of the state of the art, though it broke no barriers and explored no unexplored frontiers. But for one reason or another, it didn’t sell. Over time the inventory of Multivisions had to be disposed of at prices well below their cost of production, merely to free up inventory space for other products. There was no help for it, and nothing to be done but to recoup what few dollars could be had by liquidating the supply on hand. This is a common phenomenon in a marketplace that’s departing its “innovation” phase and moving toward “maturity.”

     Benjamin M. Anderson also provides examples of this kind in his book Economics and the Public Welfare. He’s quite explicit about how pricing behaves: “Right prices are prices that will move goods.” For there is often a cost to not pricing a good below its cost of production. Ask any business owner who’s ever needed to fight off a bankruptcy action or clear some warehouse space.

     The above are merely a few gentle pointers into a realm of great complexity. The mysteries of economics are essentially the mysteries of human behavior. Price dynamics cannot be decoupled from the elusive dynamics of human decision making. And of course, given that the State will nearly always intrude into the market, and that “social justice warriors” will egg it on to do ever more of that, the relative simplicity of supply-demand microeconomics can seem unrelated to the world in which we live. But one must start somewhere, and dismissing the essentially Marxist canard about how “cost of production should determine price,” uncritically accepted by far too many, is a good place to start.

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