The Price of Everything - Eduardo Porter [11]
There’s a cool trick that teachers have used for years to expose students to the power of this transaction. First they distribute bags with assortments of candies among their students and ask them how much they value the gift—what would they be willing to pay for their stash? Then they allow them to trade candy among themselves. If students are asked again after the exchange to assess the value of their booty, they will invariably give it a higher value than the first time. That’s because trading allowed them to match their lot to their preferences. They traded things they valued less for things they valued more. Nobody worked, yet the value of the entire allotment of candies grew.
The realization that things do not possess an absolute, inherent value seeped into economic thought in the nineteenth century. Marx’s labor theory of value eventually faded into irrelevance as nobody could figure out how his concept related to the prices at which people voluntarily bought and sold real things. Things are costly to make, of course. This puts a floor on the price at which they are supplied. But the value of a product does not live inside it. It is a subjective quantity determined by the seller and the buyer. The relative value of exchanged things is their relative price. This realization lifted prices into their rightful spot as indicators of human preferences and guides of humankind.
TAMING PRICES
Two people will be willing to trade one good for another as long as the perceived benefit from owning one more unit of what they get—the marginal gain—is at least as much as the lost value of what each trades away. This gain, in turn, is determined by the buyer’s endowment of goods: money, time, and whatever else might come into her calculation. The more one has of a given thing, the less one will value having one more. This single principle is the organizing force of markets, which determines the prices of goods and services around the world.
In a market, sellers’ priority is usually to squeeze as much money as possible from buyers. Buyers, in turn, will try to get stuff they want as cheaply as they can. They each operate within a set of constraints: for buyers a budget; for sellers, the cost of producing, storing, advertising, and bringing to market whatever they make. While producers can raise prices if consumer demand for their good grows faster than its supply, consumer demand will wane as prices rise. Above all, producers’ space to raise prices is constrained by competition. In a competitive market consumers can safely assume that prices will be kept in check as rival producers vying for consumers’ custom force them down to their marginal cost, the cost of making one more unit.
There are lots of exceptions to this dynamic, however. To begin with, fully competitive markets are rare. In markets for new inventions, legal monopolies called patents allow companies to charge higher prices than they would in a competitive field in order to recover the up-front cost of their invention. Local monopolies are common—think of the popcorn vendor inside the movie theater. Even in markets for run-of-the-mill products, producers will do their best to keep competition at bay. A tried and tested tactic is to convince consumers that their product is unique, muddying comparisons with rivals’ wares. Another is to lock in consumers with a cheap product that, it later becomes apparent, only works in conjunction with some higher-priced good. Another is simply to hide their prices from consumers’ view.
Unacknowledged