Four Things People Don’t Understand About A Free Market Price
By David Grace (www.DavidGraceAuthor.com)
Many people are confused about what the market price of goods and services really means and how it is set.
1: The Market Price Is NOT A Measure Of A Product’s Abstract Value
Some people think that the market price for a good or service is somehow a measure or an indicator of an inherent, independent value of that good or service.
Others think that the market price for a good or service can be higher or lower than some abstract, inherent value of that good or service.
All those people are wrong.
The market price tells us nothing about the product’s abstract value because a product or service has no independent, inherent, abstract value today.
A product or service only has an actual value which is what a ready, willing, and able buyer offers to pay to a willing seller today.
Yes, if we had
- a perfect crystal ball and
- we could be sure what the market price for a good or service would be at a specific date in the future and
- if we could be sure of the proper discount rate to apply over that intervening time period and
- if we could cheaply store that product until that future date and
- if we knew that cost of storage and the amount of degradation of the product over that time period
then we could calculate the future value of that product discounted back to its present value.
Except for those extremely rare cases when that can be done, a product does not have an inherent, abstract value today that is different from its market price today.
2: The Market Price Is NOT A Measure Of A Product’s Usefulness
Some people think that a product or service’s price is related to or is a measure of its usefulness.
Those people are wrong.
The market price for a good or service has nothing to do with its usefulness.
In a competitive market, in spite of its great usefulness the price for a life-saving drug might be $5 per month while in spite of its small usefulness the price for a particular woman’s handbag might be $10,000.
The price of neither product bears any relationship to the usefulness, importance or some theoretical, inherent value of either product.
For a more detailed discussion of this myth that price bears some direct relationship to usefulness, see my column:
A Product’s Price Has, & Should Have, Nothing To Do With Its Usefulness
3: The Market Price Is Only A Measure Of The Strength Of The Buyer’s Bargaining Power Compared To The Seller’s Bargaining Power
A product or service’s price is a measure of one and only one thing:
- The bargaining power of the seller in relation to the bargaining power of the buyer at that moment in time.
The difference between the hourly wage paid to unskilled union workers and the hourly wage paid to unskilled non-union workers is due to only one thing: the greater bargaining power of union workers.
As rape is about power, not sex, price is about power, not usefulness or some notion of abstract worth.
A Demonstration Of How Bargaining Power Affects Price
Scenario Number 1
The factory in a small town has closed and a skilled mechanic has lost his job. He is only able to find a part-time, minimum-wage replacement job and the situation for his wife and children soon becomes desperate.
A wealthy local businessman has an older BMW in his garage which is unsalable because it has a blown engine. If the car were in good condition the businessman could sell it for $5,000. The businessman is not under any time pressure to sell the car and he does not need it to be repaired right away.
The businessman learns about the mechanic’s desperate need for money and he makes the mechanic a proposal: rebuild the BMW’s engine and the businessman will give him a flat payment of $500 and he will also pay for all of the parts. The job will take at least 50 hours of work which means a pay rate of $10/hour or less.
Because the mechanic’s family is about to be evicted from their home for nonpayment of rent, the mechanic agrees.
Scenario #2
Now, except for one thing, everything about scenario 2 remains the same as Scenario 1:
- The same car,
- The same services,
- The same number of hours of work,
- The same businessman
Everything is the same except in this second scenario the factory did not close, the mechanic did not lose his job, and he is not in desperate need of money.
Again, the businessman approaches the mechanic and offers $500 which offer the mechanic refuses. The parties continue to negotiate and they eventually agree on a payment of $1,500 instead of $500.
In the second scenario the price for the mechanic’s labor went from $10/hour to $30/hour even though the buyer (the car’s owner) and the seller (the mechanic), the amount and type of services (50 hours of labor) all remained exactly the same.
The only thing that changed in scenario two was that the mechanic’s bargaining power increased because he was no longer under financial pressure to accept whatever price the businessman offered.
In scenario #1 the $10/hour price for the mechanic’s services was not a measure of the value or usefulness of the mechanic’s services any more than the second scenario’s price of $30/hour was a measure of the value or usefulness of the mechanic’s services.
In both cases the price for the mechanic’s services was solely determined by the relative bargaining power of the mechanic-seller versus the bargaining power of businessman-buyer.
Like other products and services, the price for unskilled labor is not a measure of the usefulness or any inherent value of the unskilled labor.
A market price for unskilled labor of $10/hour does not mean that an hour of unskilled labor is “worth” $10. It only means that the bargaining power of the buyer of unskilled labor (the employer) is sufficiently stronger than the bargaining power of the seller of unskilled labor (the worker) that the employer is able to get the worker to sell his unskilled labor at that price.
4: Highly Unbalanced Bargaining Power Results In Market Prices That Are Detrimental To The Economy
Some people think that the market price for a good or service is always the most beneficial price, the most efficient price, the right price for that good or service.
Those people are wrong.
When the bargaining power of the buyer is roughly equal to the bargaining power of the seller the result is usually a competitive price which is cost + overhead + a reasonable level of profit. A competitive price benefits consumers and results in an efficient allocation of resources for the economy.
Excessive Seller Bargaining Power Leads To Monopoly Prices
But, when the bargaining power of the seller is hugely greater than that of the buyer the price increases from a competitive price toward a monopoly price.
A monopoly price is never efficient for the economy or good for the country because it overcompensates the seller and diverts resources away from the sellers of other goods and services thus hurting the economy and impoverishing consumers.
Excessive Buyer Bargaining Power Leads To Boom & Bust Product Cycles
When the bargaining power of the buyer is hugely greater than that of the seller to the point that the price is reduced to or below cost, it will, if it continues long enough, drive the seller out of business. When this happens there is the possibility of a boom and bust product cycle.
We see this with farmers who are often driven into bankruptcy in bumper-crop years leading to a shortage and higher prices in succeeding years.
The Economy & The Country Benefit From Relatively Equal Buyer-Seller Bargaining Power
It is in the best interests of the economy and the country to equalize as much as reasonably possible the bargaining power of buyers and sellers so that, as much as possible, the market produces competitive prices rather than either monopoly prices or below-cost prices.
— David Grace (www.DavidGraceAuthor.com)
