Van Cott: The Myth of Marketplace Chaos
Editor’s Note: Although Indiana’s price-gouging law refers only to the price of gas during a state of emergency, Gov. Eric Holcomb, reacting to reports of high prices for certain items in high demand during the Chinese coronavirus epidemic, is urging citizens to file a complaint with the attorney general about unexpected price increases. We think the author has a more informed perspective.
by Norman Van Cott, Ph.D.
Buyers and sellers have conflicting objectives. Buyers want low prices. How low? As low as possible. Sellers want high prices. How high? As high as possible. Sounds like a recipe for chaos in the marketplace, doesn’t it? Lots of Americans think so. The mind-set has pervaded our nation at least since Franklin Roosevelt’s 1930s New Deal.
This notion of marketplace chaos is bogus, however. Never mind the fact that many otherwise intelligent Americans have embraced it. Also bogus is the companion notion that reconciliation of buyers and sellers’ conflicting objectives is possible only if government economic “czars” prescribe the terms for buyer/seller interaction.
Just because buyers want prices as low as possible doesn’t mean they’re not willing to pay higher prices. What someone wants to do doesn’t indicate what they’re willing to do. Take peaches as an example. As long as their price is less than the consumption value people attach to peaches, buyers will benefit from buying them. Similarly for peach producers. Just because they want a price as high as possible doesn’t mean they won’t be willing to sell as long as the price is greater than alternative selling options.
It follows that as long as there is a range of peach prices simultaneously less than buyers’ consumption valuations and greater than sellers’ other selling options, mutually beneficial opportunities exist for buyers and sellers to interact in the marketplace. Buyers won’t gain because sellers lose, nor will sellers gain because buyers lose. Buyers and sellers simultaneously gain. Chaotic? Hardly.
What if the above range of prices doesn’t exist? Simple. Peaches will not exist either. Indeed, absent simultaneity of buyers and sellers gaining, there will be no markets. This doesn’t sound chaotic either.
Production and Consumption Assignments
Peach buyers naturally gravitate to lower-cost producers. These producers will be able to — not want to — sell at lower prices. Cost is a yardstick for opportunities given up. Giving up less of other things to get peaches means you can have more of other things.
Peach sellers desiring to sell at higher prices instinctively search for buyers willing to — not wanting to — pay higher prices. These are the buyers who value peaches more highly. Any other assignment of production tasks or consumption benefits lowers peaches’ contribution to overall living standards. Chaotic? Not so.
All this occurs as a consequence of buyers and sellers of peaches trying to enhance their own well-being. Market participants, in other words, unintentionally do good for others while intentionally doing well for themselves. Or as Adam Smith put it in his 1759 treatise, “Theory of Moral Sentiments”:
“. . . he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”
So what do peach buyers and sellers need to know to participate in the market? Precious little. All any buyer needs to know is the price and his or her maximum willingness to pay. Buyers need not know anything about their counterparts’ willingnesses to pay or personal characteristics. Likewise, buyers need not know personal information about sellers. Nothing chaotic here either.
A peach seller only needs to know the price and his or her minimum acceptable price — that is, their next most lucrative selling opportunity. This means that sellers, like buyers, don’t need to know their counterparts’ minimum acceptable prices or personal characteristics. Nor do they need to know any details about the buyers with whom they interact. What’s chaotic about this? Nothing.
Nevertheless, the marketplace assembles all this information about the terms on which buyers and sellers (individually) enter the marketplace. Any buyer or seller knows precious little, but the full panoply of information is operative in the marketplace. Pretty amazing if you ask me. Forces are at work that continually push to get peaches produced at minimum cost and consumed in their higher valued uses.
What about Government “Czars?”
What would a peach czar need to know in order to match the marketplace? Everything! In order to get peaches produced at minimum cost, the czar would have to know everyone’s minimum acceptable price. Similarly, to get peaches to their highest consumption valuations, the czar would have to know everyone’s consumption valuations. What’s the likelihood of this? Zero.
It makes no difference how many computers the czar has or how high his or her IQ. They will not be able to match a marketplace where individual participants need know almost nothing about those with whom they interact. Anyone who thinks czars can match the marketplace is either profoundly stupid or delusional. Friedrich Hayek labeled them subject to a “fatal conceit.” Did he go too easy on them? I think so.
One should expect market conditions to change. Indeed, buyers’ consumption valuations can obviously change, either across the economy or in segments of the market. Likewise, sellers’ alternative selling options can change. Do these changes breathe some life into the marketplace chaos notion? No. In fact, the result is quite the opposite.
Let’s consider a product other than peaches. Chainsaws and generators following a hurricane that sweeps up the Atlantic coast bringing downed trees and electric-power outage for many Americans are a great example. The immediate consequence would be an increase in consumption valuations for chainsaws and generators in the affected areas. The prices of these items will rise in these areas.
These price rises will have two important consequences. First, it increases the cost of selling chainsaws and generators in areas not hit by the hurricane. As a result, sales of these items will fall in the unaffected areas. What happens to these “unsold” chainsaws and generators? They go to the hurricane-struck area to take advantage of the higher prices there. The higher prices also provide an incentive for chainsaw and generator producers to increase production. For whom? Again, residents of the hurricane-struck area.
It follows that the marketplace has a mechanism to assist those suffering from hurricane damage. That mechanism is the higher prices. They reallocate existing production and increase production. Information requirements for buyers and sellers are unaffected. All they need know is the price and their respective willingnesses to pay and selling alternatives.
Most know, of course, that prices of items like chainsaws and generators are not permitted to rise following hurricanes. Most state and local governments freeze such prices at their pre-hurricane levels. This means that affected residents are denied the marketplace’s mechanism for easing their plight. They are left with concerned citizens in the rest of the country and government agencies trying to provide assistance, none of which possess sufficient information about the higher consumption valuations of the items they dispense.
If you want to know a true recipe for a chaotic marketplace, imagine again what would happen if the peach market were administered by a czar. That the czar would have any idea about peaches’ lower cost producers and higher valued consumption outlets is ludicrous. Likewise for the czar knowing what price(s) will result in all potential trades being consummated.
Rather than buyers competing among themselves, and sellers competing among themselves, based on price and quality issues, buyers and sellers will be competing for the attention of the czar. In other words, competition shifts from the economic marketplace to the political marketplace.
The “coin of the realm” becomes political “money.” What is this latter money? How about campaign contributions to those in power? How about bribing the czars? What about various forms of racial, ethnic and ideological discrimination? Similarly for a policy of rewarding your friends and punishing your enemies? Chaos? You bet. Chaos accompanied, moreover, by a decline in living standards.
T. Norman Van Cott, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, was formerly chair of the Ball State University Economics Department. A version of this article was posted April 1, 2020, on the website of the Foundation for Economic Education.