INTRODUCTION TO ECONOMICS
Lesson 6 given at Alia College
PRICES, RENTS & WAGES
WHAT IS A PRICE?
Depending on whether one holds that a price, by definition, refers only to money or not, a price is either the amount of money required to exchange for a specific or a specific amount of a good or service or alternatively, the amount of one thing required to exchange for a specific or specific amount of an other. Thus we can say that the price of a particular pen or of a kilo of apples is say $2. Alternatively, accepting that price need not relate only to money, we can say that it is 2 kilos of potatoes or an eye check from an oculist.
Price to a lawyer is a monetary consideration. Economists generally prefer the wider definition, which does not confine itself to money.
HOW ARE PRICES SET ?
Prices are set through the interaction of supply and demand. The price of something will depend on how much people want it and how much of it there is on offer to exchange. In economics this is often portrayed graphically, using demand and supply curves. Accepting that, with demand, if the price falls, demand increases and, with supply, if the price falls, supply decreases and using the vertical axis for price and the horizontal axis for quantity then the demand curve will slope down from left to right whilst the supply curve will slope up.
Prices constantly tend towards their equilibrium ie. the point where the demand and supply curves intersect. In that regard they are like a well-found boat which may be constantly pitching and tossing but always tending towards the horizontal. The process is dynamic, not static.
IMPORTANCE OF PRICES
Price is one of the most important of economic concepts. If one wished to try to sum up economics in one word that word would be ‘prices’. Prices are the signals or indicators that largely determine the levels of production and consumption in a competitive economy. In turn this largely determines income, investment and the level of resource utilization. There are a number of diverse economic theories that attempt to explain how this occurs.
Economic theory generally would suggest that any interference with the free determination of prices in the market results in less efficient indicators and consequent wasteful and destructive distortions in the economy. Not all economists, however, would necessarily agree with this view.
There is considerable community ignorance of the importance of prices and the role they play in the functioning of society. For example, we continue to see publicly presented simple mathematical extrapolations of the consumption of various commodities contrasted against their known or possible reserves, leading to the suggestion that their exhaustion, generally in the short term, is inevitable. Such forecasts almost always fail to take into account the role of prices. Demand for a good decreases if its price rises. Price rises occur if supply fails to keep up with increased demand. If supply is threatened with exhaustion, the rise in price is such as almost invariably to cause a switch to a cheaper substitute. Thus when demand for whale oil drove up the price and threatened the whale with extinction consumers switched to mineral oil. If mineral oil reserves were threatened with exhaustion the accompanying rise in price would cause consumers to switch to a cheaper alternative long before exhaustion occurred. In this way prices direct the most efficient use of resources.
RENTS & WAGES
In economics, rent is a price. It is the technical word used to describe the hire price of the factors of production, which are usually defined as land, labour and capital. In common parlance however rent usually refers to the hire price of land and tangible personal property other than money, whilst the hire price of labour is generally referred to as wages. The hire price of money, again in common parlance is referred to as interest and that of intangible or intellectual property as royalties.
There is much argument as to whether land rents and wages, particularly wages are different in an economic sense from other prices. Regardless, for a variety of reasons they are almost invariably treated separately.
INFLATION, DEFLATION AND STABLE PRICES
The most widely used definition of inflation is a general increase in the level of monetary prices. A better economic definition of inflation is any increase in the supply of money. This usually [but not always] will result in a general increase in the level of monetary prices, often quite significantly. Inflation is a monetary phenomenon. Businesspeople tend to be happy with a small amount of inflation This is because rising prices tend to overtake business errors. If a businessperson has overpaid in his or her operation today rising prices tend to nonetheless enable them to recover the investment tomorrow. Deflation, which is the opposite of inflation, has a contrary effect. Governments tend to prefer stable prices perhaps because stable prices emanate an aura of a government in control. Much government policy is directed towards trying to ensure stable prices. It is arguable however that the most desirable situation at least for consumers [and we are all consumers] is a gentle deflation since a given amount of money today will buy more of whatever is desired tomorrow. In a general sense we can all be seen in such circumstances to be gradually getting richer.
Price controls [including rent and wage controls] are measures imposed by government to restrict or prohibit movements in prices, whether up or down. They are essentially government commands backed by the threat of civil and/or criminal sanctions. Economists have sought to distinguish various reasons why governments impose controls and have identified a number of different motives. One such motive is to attempt to preempt or retrieve a market situation that is threatening to get out of hand such as occurs with runaway inflation, war or a natural disaster. Another can be an endeavour to implement a desired policy such as minimum wages or so-called orderly marketing and so forth.
As a general proposition, most economists are opposed to price controls. They result in gluts if a price is held up and shortages and black markets if it is held down. More importantly, any interference with the free movement of prices results in a decrease in their effectiveness as market indicators and as determiners of future production, consumption and so forth. This decreased effectiveness is a major cost to the community
The arguments can be illustrated by historical examples. During the first siege of Breda by the Spanish the Dutch held out despite enduring significant deprivations. The city government allowed prices to rise and traders outside of the besieged city were accordingly prepared to run the risk of the Spanish blockade to bring supplies to the city. During a second siege however the city fathers imposed price controls. Deprived of any incentive the blockade-runners did not come and the city soon fell. In 1906 almost half the housing in San Francisco was destroyed by an earthquake. Demand for accommodation skyrocketed literally overnight. The government did not impose rent controls. The dispossessed were swiftly accommodated in the remaining housing stock albeit at rents which a short time previously would have been regarded as exorbitant.
The concept of a ‘just price’ is an old one dating back at least to the Ancient Greeks. It is more generally associated with the Christian philosophers of the Middle Ages. It related to what was sinful rather than illegal and to that extent had more to do with morality than economics or law. The test of determining what was a just price was always difficult and some scholars certainly subscribed to the view that the just price was the market price. In so far as it was a moral matter it had the positive effect of enjoining participants in the market process to treat the other party or parties fairly. It has been suggested that the concept of a legal just price had particular relevance in an era where although there were some markets with many buyers and sellers there were many markets which were isolated and/or which had only one or a few buyers and sellers so that arguably the concept of a just price promoted market efficiency.
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