PRICES Part one

One of the toughest classes I had (at my surprise) in college was The History of Economic Theory. The thing that was toughest to understand was the history of setting prices on goods. How to come up or set a price for a good has been debated and studied for centuries especially since the 1700's when the study of economics really began with Adam Smith's The Wealth of Nations book came out. Smith is considered the "Father of Capitalism" some call him the "Father of Economics". I am now going to do the best I can to explain why prices are set the way they are today and answer some recent questions and complaints from friends of mine who do not understand why gas prices have fluctuated so much lately and is there manipulation going on.

Should prices be set just above cost? This way the producer will make just a little profit to pay him for his work and pay him enough to cover his cost. Should prices be set exactly at cost? Should government set prices? Should government subsidize or help pay for important goods so that consumers or citizens can pay less for a good they need since the government is helping pay for part of it? All interesting questions but they are the wrong questions. The question should be: In relation to setting prices what is the most efficient way to get goods produced, allocated or spread throughout the economy, and bought by customers to satisfy their needs and want. In other words: Supply and Demand. I find the theory of Supply and Demand one of the most interesting concepts in the world. I know I must be a geek but so be it. In a true free market (which has shown to be the most efficient way of allocating resources) prices are set wherever producers want to put them..... but not exactly. What do you mean Jess "but not exactly"? Consumers can buy products at whatever price they want to by telling the producer "NO" by not buying their good at that current price. In a free market there is competition and only very very few technical monopolies and thus competition will allow consumers to have the most power in the economy not the producer. This is because there are far more of them! So the consumer can not be taken advantage of in a true free market.

Producers want to make as much as they can but if they charge too much they will not have buyers and thus go out of business. This is why Wal-mart has been so successful in selling for cheap and thus other businesses that charge more are put out of business. Not by Wal-mart. But put out of business by US the consumer who chooses to buy from Wal-Mart instead of them. Prices thus are set by a market of producers (the suppliers) and consumers (the demanders). Now lets apply this to prices in our economy.

Economist that think like I do, do not care about how much it cost to make something and thus producers should make a little profit to pay them for their services. They care about what people are demanding, thus what needs to be produced, and the price can determine both of these things. How? The higher the price the more suppliers will make of that good because they can make a lot of money. Plus that higher price serves another great function. It curves demand for that good. In other words, if the price is high, because there is a lot of demand for it, you will buy less of it because at a high price you will only buy what you need, not necessarily what you want. The good news is that because of this action, there is more of the good to go around to ALL people that need it. Back to that first good thing. The higher the price the more that good will be produced. This means what people demand the most will be made the most and quickest so that consumers can get it and producers can make a buck. Or in this case, a lot of bucks. But in the long term, that means the supply will rise, and eventually over take demand, and thus producers will lower prices to sell off their extra supply. This is why goods that are made are expensive at first (video games, new types of technology like computers and cars, medicine, etc...) and then later the price falls. Then a new, better technology comes out, the price of the older technology falls even more, but the new goods price is high, and the same thing happens all over again.

In the next posts I will explain why this is good, and its effects on gas prices, and why so many Americans complain about price gougers, and manipulation and so forth.