What Does Price Tell Us?

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Introduction

Price in our society is most often non-negotiable. The teenage boy working at the local supermarket is not going to entertain attempts to haggle on price and the manager at the gas station is not going to let you talk her into knocking twenty-five cents off per gallon. The price you see is the price you pay, but it can change from week to week. One day a gallon of milk could be $4.00, the next it might be $5.25. Obviously, if you value that gallon of milk highly, you will buy it at an even higher price until you decide it’s not worth it. These decisions sound complex but really they are snap decisions that we make in our heads every time we pull out our wallets. We see a number that we must pay to procure an item, but that number is not arbitrary; there is a lot of information packed into a few digits and it can tell you a lot about multiple industries.

Production

There is an awful lot that goes into production that is often overlooked. Bylund uses production of apples as an example in his book. There are things like soil, seeds, equipment, water, property, time, and much more that are important factors of producing a single apple (pp. 27-45, 2016). This creates a sort of “chain” of production. Entrepreneurs have to buy resources from other entrepreneurs to produce their product. The price that entrepreneurs have to pay for these resources has a direct impact on the price that they will charge consumers for their product. If apple seeds are scarce and in high demand, an apple orchard owner will have to pay a premium for seeds, and in turn will have to charge a price for the apples that makes the purchase of the seeds a worthwhile investment. This is all not even taking into consideration the time of production. For something like fruit, it could take years from planting a tree to getting a usable product. The opportunity cost of the land and time it takes could be a great one. These are all things that factor into what you pay at the store. The apple tree example could even be taken a step further to the production of apple juice or some other apple derivative. Now the chain goes from apple seeds, to apple tree orchard, to apple juice production. All down that line there are associated costs and associated time of production which can influence how much apple juice costs at any given time.

The Market

An entrepreneur can make the necessary purchases to begin production, but there is no guarantee that once a product is ready to take to market, that individuals are 1) going to want to pay enough for the product to make it a worthwhile investment of time and money, or 2) going to want the product at all. Therefore, there is an inherent risk with a good that has a longer time of production because there is more time for consumers to change their wants. A successful entrepreneur fills the gap in the consumer's life while maximizing what they can get for the resources they used themselves, and society is better off as a whole. Bylund sums this concept up nicely with:

“entrepreneurs earn profits or suffer losses based on how well their actions satisfy real consumer wants. And through their productive efforts, they generate the prices that guide other entrepreneurs. In other words, the unhampered market aligns incentives in such a way that it is in the individual’s interest to serve the interests of society, which empowers the individual to seek ways of providing even greater want satisfaction” (p .44, 2016).

I particularly like the part of the quote where Bylund talks about this “alignment of incentives”. In a successful free market, serving the wants and needs of the consumer is beneficial to the producer because he is often rewarded with the ability to charge more for his goods. And the individuals before him in the chain of production are rewarded with the same. When individuals work together to provide for society, not only is society better off, but those who contribute are as well.

Communication of Knowledge

At the very root of its purpose, price serves to convey the coordinated knowledge of individuals from many disciplines. These people combine their heads to not only produce a good but also to tell a story about its production. The knowledge of everything it takes to start with nothing and produce a single apple is impossible for a single individual to know. Each field involved is too complex. Between the heavy machinery required to prepare the soil, to the complex irrigation to efficiently water the orchard, to the chemical composition of the seed which will eventually become a tree, and so much more, knowledge has to be shared across industries for anything to get done. Hayek stated,

"It is evident… that the values of the factors of production do not depend solely on the valuation of the consumer’s goods but also on the conditions of supply of the various factors of production. Only to a mind to which all these facts were simultaneously known would the answer necessarily follow from the facts given to it. The practical problem, however, arises precisely because these facts are never so given to a single mind, and because, in consequence, it is necessary that in the solution of the problem knowledge should be used that is dispersed among many people” (p. 530, 1945).

This problem he refers to is about efficiently using resources to provide the best possible outcome to society. This of course could not be known by a single person, and could only be solved by many individuals from many different professional backgrounds coming together to share the information that they have. This is done on a microscale with price. Individuals come together and decide what they want to put their resources toward and the price of each factor of production goes into determining the price of the product.

References

Bylund, P. L. (2016). Chapter 3: What Prices Communicate. In Seen, the unseen, and the unrealized: How regulations affect our everyday lives (pp. 27–45). essay, Lexington Books.
Hayek, F. A. (1945). The Use of Knowledge in Society. American Economic Review, 35(4), 519-30.