Tuesday , September 22 2020
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Economics: Prices, Pri-ces, P.R.I.C.E.S.

Summary:
It is impossible to understand the economy—that is, the economic consequences of individual actions—without understanding the role that prices play or are prevented from playing. This was a crucial scientific discovery of modern times. For that very reason, microeconomic theory used to be called “price theory.” So it is troubling to observe that many of our contemporaries and even many financial journalists ignore that discovery. Even economists tend to forget it when their moral values or virtue signaling is at stake. An illustration of the problem was given by a Wall Street Journal feature of August 21 titled “Why Are There Still Not Enough Paper Towels?” The role of prices and price controls is nowhere mentioned. The very word “price” only appears twice, mainly

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It is impossible to understand the economy—that is, the economic consequences of individual actions—without understanding the role that prices play or are prevented from playing. This was a crucial scientific discovery of modern times. For that very reason, microeconomic theory used to be called “price theory.” So it is troubling to observe that many of our contemporaries and even many financial journalists ignore that discovery. Even economists tend to forget it when their moral values or virtue signaling is at stake.

An illustration of the problem was given by a Wall Street Journal feature of August 21 titled “Why Are There Still Not Enough Paper Towels?” The role of prices and price controls is nowhere mentioned. The very word “price” only appears twice, mainly from a management perspective: the competition of “Japan’s low-price cars” in the 1970s and the fact that overcapacity “would not allow you to price in a way that meets customer needs.” This last phrase, from P&G’s chief executive, could be read as referring to prices established on free markets, but it is as close as the story comes to prices. Not surprisingly, the report cannot explain why a shortage of paper towels persists:

The United States of America, heralded as the land of plenty, still doesn’t have enough paper towels. … An average of 21% of household paper products were out of stock at U.S. stores as of Aug. 9

The story’s “economic” explanation is essentially that

[t]he scarcity is rooted in a decadeslong quest by businesses at all levels, handling many different products, to eke out more profit by operating with almost no slack.

In other words, the culprits are bad capitalists who are trying to maximize profits with tricks such as lean manufacturing and just-in-time delivery. The authors do not conclude, but could as well have concluded, that this is why so few shortages exist under communism and socialism, in Cuba or Venezuela, not to mention the former Soviet Union.

The real reason for persistent shortages, as I explained in many recent Econlog posts (including “Why Shortages Are Not More Widespread,” August 17), is that prices are capped under the threat of government prosecution. It is that consumers are forbidden to bid up prices. It is that bad capitalists are forbidden to maximize profits to respond to consumer demand, except sometimes stealthily. Being an obedient government crony is becoming an easier path than serving consumers.

The featured image of the present post is a photograph I took last week of the gun counter at a major retailer in Maine. It illustrates what a “land of plenty” looks like when price adjustments along supply and demand curves are forbidden.

The Wall Street Journal story has some feebly redeeming value. It provides many examples of why marginal cost increases with production. It hints at the fact that reducing product diversity has been a stealth way of responding to consumer demand despite price controls. But as a purported explanation of why shortages persist, it is at best misleading.

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