“Everything has a price.” ~ Paul Samuelson
Neoclassical theory critically depends upon the price mechanism as a realistic explanation for how prices are set and markets behave. If instead the price mechanism is an unreliable compass, neoclassical economics is a hoax.
In market-based economies, price acts as an incentive to potential suppliers: either prompting production of a good or stifling its manufacture, depending upon whether the present price offers the prospect of profit. The basic idea is that more of a good might be had if it has a higher price.
Economists refer to a product as a good, which by definition places a positive value judgment toward all material things consumed. No one worships mammon more than an economist.
The notion that price positively affects supply may be plotted on a chart, with quantity laid out horizontally while price rises up the vertical axis. A supply schedule slants upward: the higher the price, the more of the good will be made available.
Rising price may indeed spur additional supply. But an upward-sloping supply schedule does not always hold true.
Once the means of production are set in place, companies may produce more goods even if the price falls, especially when the current price is still above cost. The fond hope behind that is that the goods made will be sold at a profit.
Oversupply is a habitual problem in modern market economies. Falling prices may provide an opportunity for a dominant supplier to drive weaker competitors out of the market by bankrupting them.
In the instance of monopoly, there is no supply curve: a monopolist seller sets price as it sees fit. The idea of a supply curve is also a sham with an oligopoly, where a few firms can easily collude to set prices.
More generally, the supply schedule critically depends upon market conditions: specifically, that the industry is in perfect competition, where firms cannot influence the price at which they sell, but instead must take price as given. All firms are assumed to produce a homogeneous product, such that consumer brand loyalty should not exist. Every regular shopper knows this is not true.
Throughout the analysis of perfect competition, the assumption is made that the perfectly competitive firm is so small, relative to the overall market, that its impact on the market can be treated as zero. ~ Steve Keen
Unless there is perfect competition and sellers have complete information, which is another fictional ideal, the shape of a supply schedule supposedly acting to efficiently allocate resources is hypothetical hooey.
Unless perfect competition rules, there is no supply curve. ~ Steve Keen
There are many reasons that supply may be insensitive to price for sustained periods: the nature of the good, such as whether it is subject to spoilage or is otherwise available for limited times; production parameters, such as how much capital is involved in its production (sunk cost) or the availability of labor; and market conditions, most notably the current dynamic of competition among suppliers.
Buttressing the notion of a supply schedule is the concept of marginal cost: what it takes to make more.
Cost is the starting point for a supplier determining the price at which a good can be profitably sold. Cost includes design, manufacture, packaging, marketing, and distribution: the total outlay of capital, materials, and labor involved in making a product and presenting it to a potential consumer.
Marginal cost is the incremental cost of producing an additional unit of the same good. In calculus terms, marginal cost is the 1st derivative.
Marginal considerations are considerations which concern a slight increase or diminution of the stock of anything which we possess or are considering. ~ English economist Philip Wicksteed
Under the unrealistic assumption of perfect competition, supply of a good in the market is hypothetically determined by marginal cost. The canonical assumption is that firms willingly produce extra output as long as the saleable price of a good is more than the cost to make an extra unit.
Neoclassical theory posits that the marginal cost curve slopes upwards, as productivity presumably falls as output rises: a higher price has to be offered to entice firms to produce more. Though this may sound plausible, an upward-sloping marginal cost curve has no factual basis. When this concept of marginal cost was put before those who do know how factories are designed and managed, they rejected the theory as “the product of the itching imaginations of uninformed and inexperienced armchair theorizers.”
(One of the more peculiar aspects of modern life is that most people have no idea how the commodities they consume are produced. Only a small and decreasing number of workers are directly involved in production, and only a few of those know how factories are managed and designed. In contrast to consumption, which is rather obvious, the conditions of production are a mystery. This ignorance applies to economists.)
Engineers purposely design factories with significant excess capacity, to avoid the very problem that economists assume forces rising production costs. Only goods that are not produced in factories, such as oil, might have short-term production costs as economists expect.
Neoclassical economic theory was formulated in an earlier age, when the dynamics of scarcity and scale were different. What might have applied to piecemeal production has no relation to modern mass manufacture.
The upshot is that production costs are normally either constant or falling for the vast majority of manufactured goods. Hence, marginal cost curves are flat or even falling: the economic advantage of dealing of in bulk. This causes manufacturers no difficulty, but give economists conniptions, since their theories depend upon an upward-sloping supply schedule.
A demand curve runs contrary to a supply schedule. Few consumers are willing to buy high-priced goods. As the price drops, more purchases will supposedly be made: hence, a demand curve is drawn as downward sloping.
There are many instances where demand curves are upward sloping. More stocks are bought when their prices are going up. This same principle applies to all products which can cause bubbles, whether gold or tulips or houses.
Price is a signal that shapes expectations. Demand goes up if consumers expect price rises to continue, thus creating a self-fulfilling dynamic. Any good that can be resold may prompt more demand as its price goes up, as buyers anticipate selling later at a higher price (and thereby reaping a profit). This social psychology is the root of the speculative buying which has propelled many boom/bust cycles.
Some goods are necessities which are bought regardless of price. Demand curves for flour and bread were never downward sloping in Britain during the 18th and 19th centuries.
The demand curve many rise for another reason: availability and the price of substitutes. The Irish potato famine shot potato prices up due to reduced supply. With potatoes dear, bacon – the cheapest meat – substituted. Demand for bacon pigs rose along with their price during the Irish potato shortage.
A good that violates the ‘law of demand’ by not having a downward-sloping demand curve is known as a Giffen good; named by Alfred Marshall after Scottish statistician and economist Robert Giffen, who proposed the paradox after observing the purchasing habits of the poor during the Victorian era.
The community is a fictitious body, composed of individual persons who are considered as constituting as it were its members. The interests of the community then is, what? – the sum of the interests of the several members who compose it. It is in vain to talk of the interest of the community, without understanding what is in the interest of the individual. ~ English philosopher and economist Jeremy Bentham
2 assumptions lurk behind the facile assumption that demand grows at a lower price: 1) that all people have the same tastes, and 2) that these tastes remain constant regardless of wealth. Since these conditions are often not true for varying reasons for various goods, the law of demand is spurious as a generality. Demand curves may be most any shape.
Let us return now to the fictional account of how the market system is contrived to make sense. Put together a supply schedule and a demand curve and out pops an equilibrium price (the star point). This price is the intersection point where the quantity demanded equals the quantity supplied. Upon this simple mythical model lays the entire foundation of capitalist economic theory.
The belief that price and quantity are jointly determined by the interaction of supply and demand is perhaps the most central tenet of conventional economics. ~ Steve Keen
A root problem of the price model has to do with equilibrium: a tidy concept which has nothing to do with economics in the real world. The dynamics by which prices are determined do not emerge from mystical equilibrium points. Instead, prices are picked by sellers based upon their intuition of what the buyers at the moment might bear. Misjudgments trigger adjustments.
If economics is to have any relevance to the real world – if economics is even to be internally consistent – then it must be formulated in a way which does not assume equilibrium. ~ Steve Keen
A price that exceeds cost yields a seller profit. Profit is the propelling force of market-driven economies. If not for profit, nothing would be made, according to neoclassical economics.
Shifts in demand or supply arise from a myriad of causes, such as improving technology, or a change in consumer preferences. Such dynamic developments move one or both curves or alter their shapes. Even hypothetically, characterizing the price mechanism is impossible.
Both the demand and supply aspects of conventional economic analysis are unsound: first, market demand curves don’t obey the ‘law’ of demand and can have any shape at all. Secondly, a supply curve doesn’t exist. ~ Steve Keen
In economics theory, falsity scales nicely. The explanatory power of the price model – the microeconomic law of supply and demand – was generalized to explain the economy at large: total output, aggregate demand, and general price level. Demand and supply are also employed in theories of macroeconomic finance: money supply and demand, and interest rates.
An interest rate is the percentage return a monetary lender makes from a borrower. An interest rate is, in essence, the price of holding money.
Swedish economist Knut Wicksell imagined that there was a “natural rate” of interest.
This natural rate is roughly the same thing as the real interest of actual business. A more accurate, though rather abstract, criterion is obtained by thinking of it as the rate which would be determined by supply and demand if real capital were lent in kind without the intervention of money. ~ Knut Wicksell
In the late 19th century, Wicksell saw financial rates set by banks competing to make loans. The job now falls to central banks, which still think in Wicksellian terms: the natural rate prevails when the economy is at full employment. Set the policy rate above the natural rate and the economy tips into recession. Set it below, and inflation or speculation sets in.
Nowadays, the natural interest rate is often assumed to be constant. American economist John Taylor created a rule in 1993 which central banks might use to set the interest rate based upon the current rate of inflation, so as to steer the economy financially from either the shoals of doldrums or speculative bubble blowing. The Taylor rule took 2% as the real natural interest rate.
(The Taylor principle prescribes that a central bank set the nominal interest rate slightly above rising inflation or slightly below falling inflation, so as to foster price stability and engender the credibility of the central bank via consistency and predictability, thus lessening uncertainty over government policy. Central banks do not explicitly follow the Taylor rule, instead preferring to play it by ear.)
That would have been a hard sell to Wicksell, who thought the natural rate is “never high or low in itself, but only in relation to the profit which people can make with the money in their hands, and this, of course, varies. In good times, when trade is brisk, the rate of profit is high, and, what is of great consequence, is generally expected to remain high; in periods of depression it is low and expected to remain low.”
The nut of Wicksellian philosophy regarding the natural interest rate is that it varies by expectation, in context of the current economic environment. Financier responses to central banks jiggling interest rates have shown that to be apt. In actuality, central banks key one eye on inflation and the other on how they think the market would respond to a change in interest rate. Central bank policy toward interest rates is played as a game of expectations.
In 1984, the British Bankers Association, with the assent of the Bank of England, decided to collectively fix interest rates, to facilitate trading the new financial instruments which bankers were dreaming up. The London Interbank Offered Rate (Libor) became an international standard, with rates set by a committee of 18 global banks. Using an averaging process that throws out the high and lows, Libor rates are set by banks based upon what they think they would have to pay to borrow if they needed money.
You have this vast array of financial instruments that hang their own fixes off a rate that doesn’t actually exist. ~ former Libor trader
In theory, Libor is supposed to be an honest number, because, it was assumed, that banks play by the rules and give truthful estimates. In reality, the system is rotten.
1st, Libor rates are set based on bank estimates, rather than the actual prices at which banks have lent to or borrowed from one another.
2nd, banks have every incentive to lie, as they stand to profit or lose depending on the Libor rates set each day. Worse still, the transparency in the mechanism of setting rates exacerbates the propensity to lie rather than suppressing it. Weak banks do not want to signal their dilemma with an honest estimate of the high price they would have to pay to borrow, if they could borrow at all.
Unsurprisingly, Libor rates were rigged via collusion shortly after the system was set up. To keep the lending wheels greased, rates were generally set lower than market rates would have been.
Going back to the late 1980s, when I was a trader, you saw some pretty odd fixings. With traders, if you don’t actually nail it down, they’ll steal it. ~ another former Libor trader
It was one of those well-kept secrets, but the regulator was asleep. The Bank of England didn’t care, and the participating banks were happy with the reference prices. ~ yet another former Libor trader
Libor rates became embedded in the world banking system as key references and remain so today.
As the global financial crisis begin in the middle of 2007, credit markets started to freeze up. The unexploded bombs littering the banking system had banks not trusting one another; yet Libor rates remained suspiciously low given the environment.
Government regulators in the UK and US were tipped off to Libor rigging in 2008, but with the financial fiasco full-blown, nothing was done until 2012, when the banks that managed to survive their self-created maelstrom were slapped on the wrist with fines. The culprits included all international banks in the Western world. As usual, only bank minions faced lackluster criminal prosecution, with few convictions.
The scandal mortally wounded Libor, though it took years to bleed out and die. From the mid-2110s, Libor was phased out for similar benchmarks, most notably SOFR, which is a measure of the cost of US banks borrowing cash overnight. (SOFR = Secured Overnight Financing Rate, compiled by the US Federal Reserve.)
Interest rates price debt via regulated mechanics. In contrast, the prices of equities are determined with all the decorum of a barroom brawl.
The origins of the joint-stock company are lost in the mists of history. Roman companies that were organized to collect taxes and provision the Empire traded shares intermittently. In the mid-12th century, a 300-year-old water mill in southern France divided its ownership into shares.
During the 12th century, French banks had traders who managed agricultural debts on their behalf. This was the first systematic instance of brokerage.
From the mid-13th century, Venetian bankers traded government securities. By the mid-14th century, the Venetian government was concerned enough about the trade to outlaw spreading rumors which might raise the price of government debt.
The Dutch East India Company was the first venture to issue shares of stock to the general public. The reason was simple: risk. Few of the earliest voyages to the far East made it back. Investors grew trepidatious of financing individual ships on these perilous ventures. To engender investment, in 1602 the Company issued shares for its fleet, and a stake in the profits the Company made. Soon thereafter, Dutch traders creatively pioneered various derivatives, and invented short selling – a practice which the Dutch authorities banned as early as 1610.
The South Sea Bubble soured the British authorities on joint-stock companies not under the royal thumb. Despite the Bubble Act’s ban on issuing shares, the London Stock Exchange formed in 1801: more a lobbying endeavor than stock exchange at its onset. The British government finally relented on share issuance in 1825.
The first American stock exchange was founded in Philadelphia in 1790. As the burgeoning hub of continental trade, New York’s stock exchange, founded in 1817, quickly overshadowed Philadelphia’s.
Industrialization on the European continent lagged behind Britain and the United States primarily because the French and Germans did not trust their financial institutions at the time. While the continental European entrepreneur was no less clever or diligent than his English or American counterpart, he had less access to capital.
The key provision which facilitated stock companies was limited liability, whereupon shareholders had only their investment at stake. A corporation’s creditors cannot come after the personal property of shareholders.
England allowed limited liability to trade guilds and monastic communities with commonly held property by the 15th century. In the 17th century, the British crown was awarding joint-stock charters to monopolies, such as its East India Company. Joint-stock companies became a norm in North America and Europe by the end of the 19th century.
The reason stock markets exist is that companies’ appetite for capital exceeds what prudent lenders can stomach in terms of risk. Stock markets represent a democratization of risk.
From a rose-tinted perspective, stock markets let those with capital participate in economic growth by linking their savings to business profits. Another, mythical benefit is to engender the efficient allocation of capital.
The regulatory framework, necessarily so, is rigged to favor liquidity. The result was the evolution of focus in investors toward short-term gains, with knock-on infection into corporate management. Bosses became bent to “beating the numbers” at the expense of longer-range horizons. Such an environment encourages excessive risk-taking, including the sort of empire building, or, conversely, divestment, that may curry investors’ blessing.
In recent decades, the sharp edge of short-termism has rubbed off because large companies rarely turn to the equity market for new finance. When internal reserves prove insufficient, businesses prefer to borrow, as interest is tax-deductible. For many established corporations, being on the stock exchange is primarily a public-relations exposure, and a legacy of an earlier time, when the company cut its capital teeth on stock sale proceeds.
Most new companies that grow quickly do so through private investment. New flotations on the market are mainly a way for early-stage investors to cash in their stakes. Here, the effort is entirely publicity: to generate a buzz that punters too may make a quick buck by getting in on the “ground floor.” This was how the dot-com bubble blew.
A highly developed stock exchange cannot be a club for the cult of ethics. ~ German economist Max Weber
Computerized Stock Trading
The symbiosis between technology and finance has accelerated the pace of the financial markets beyond mere human capacity at all levels of the financial system. Whatever can go wrong, will go wrong, and faster and bigger when computers are involved. ~ Chinese American finance professor Andrew Lo
Programmatic trading by computers set off the market crash of 1987 that came to be known as Black Monday. At that time, the significance of algorithmic trading was slight compared to what it has become.
Technology has utterly transformed the financial system. The vast majority of day-to-day trading is done purely algorithmically. ~ Andrew Lo
It is a rigged game. ~ American stock market trader Sal Arnuk
On 6 May 2010, the US stock market seriously swooned in a mere 5 minutes, and share prices became incomprehensible for a half hour. A single firm, Waddell & Redd Financial, caused the conniption by trying to programmatically hedge its investment position in an aggressive and abrupt manner, to which the entire market took umbrage.
Another such episode ensued on 1 August 2012. The responsible brokerage firm, Knight Capital Group, lost $440 million in minutes to algorithms gone haywire.
On 15 October 2014, the US Treasury market crashed for 10 minutes. Experts hypothesized at the time that the “activities of electronic trading algorithms” were to blame, but no proof has been found of how it happened.
We don’t understand the financial network. Even regulators don’t. ~ Andrew Lo
On 8 July 2015, the New York Stock Exchange was paralyzed for 4 hours by a software update the exchange’s engineers installed the night before.
People think all this complexity is somehow inevitable. It’s not. It’s there to shield wealthy and powerful people when things go wrong. ~ American law professor Frank Pasquale
1962 Flash Crash
Computerized trading only accelerates the irrationality which pervades stock markets. On the last 28 May 1962, the American stock markets suffered a “flash crash.”
The stock market careened downward yesterday, leaving traders shaken and exhausted. ~ The Wall Street Journal on 29 May 1962
The 1962 “market break” came after a run-up that had lulled many investors into complacency. In 1961, stocks rose 27%, with leading technology stocks trading at up to 115 times earnings. (Historically, price/earnings (P/E) ratios have averaged between 10 and 20, with a wide range between bull and bear markets. At the height of the dot-com bubble, the median P/E was 32.)
For the economy as a whole, the year and a half preceding the market break was a period of hesitation. Doubts concerning the economy were certainly not reflected in the exuberant stock markets of 1961. There was an atmosphere of feverish speculation. ~ SEC report on the 1962 stock “market break” (The SEC is the US Securities and Exchange Commission, which is the federal agency responsible for stock market regulation.)
While high-frequency trading did not exist in 1962, “specialists” did. By law, specialists were obligated to try to maintain a fair and orderly market. No such thing happened: specialists did their best to make hay, not calm.
Some orders were executed at prices substantially different from those which prevailed when the order was entered. ~ SEC report
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The markets’ erratic behavior prompted concern and caused bewilderment at home and abroad. This break had a strong and immediate psychological impact upon the Nation. ~ SEC report
The stock market continued to be volatile throughout the month of June 1962, and only began to steadily climb again after the Cuban Missile Crisis ended in October.
Despite public pressure to clean up trading procedures, nothing changed in the wake of the 1962 market break. By the summer of 1968, billions of dollars of trade were going astray every month.
Stock prices at the market open tend to be higher than at the previous day’s close. The pessimists pack it in by the end of the day.
Whereas stocks are traded during the day, the real profit comes at night, when the exchanges are closed to regular trading. Cumulate separately the daytime and after-hours returns, and it turns out that all the price gains on the New York Stock Exchange 1993–2007 came outside normal trading hours. For the past quarter century, day trading has been a desert of loss with oases of gains. The nighttime is the right time to be in the market.
Forget about the news and the market ups and downs during the day. They are nowhere close to what they are cracked up to be. ~ American stock analyst Paul Hickey
One of the laughable myths economists hold about the stock market is that it is an efficient way to allocate capital. This is based upon the assumption that investors have some savvy about the products of the companies they put their money on.
When a new product is preannounced, the short-term reaction of the stock market is unreliable. It’s really a flip of a coin. ~ Turkish-American marketing professor Ahmet Kirca
General Motors’ stock got a boost when it announced in 2003 the new Chevy SSR, a retro-style pickup truck. Yet SSR sales never took off, and the model was discontinued 3 years later. Conversely, Honda’s sole entry in the highly competitive US truck market – the Ridgeline – survived investors’ initial negative reaction in 2005 to haul in profits for many years.
Apple Computer stock dipped 6.7% in the 3 days after it announced its new iPad tablet computer in 2010. The iPad went on to be wildly successful.
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In a market economy, where transactions for exchanging goods are unrestrained, prices supposedly reflect a gyre of interaction between supply and demand, albeit with at least one (more) glaringly unrealistic constraint: if the same thing is for sale in various places, economists have faith that the law of one price holds true. The law is an axiomatic belief: that in an efficient market, identical goods all have the same price. The law of one price is a nicety that has no factual basis: bargain bins and price-gouging illustrate the point, to the respective delight and consternation of consumers.
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Conventional economists believe that markets are naturally efficient, but admit that distortions do occur, owing to various causes: such as buyers not having perfect information or government regulations which tamper with the wondrous workings of the otherwise free market.
Markets are not autonomous, spontaneous phenomena operating according to their own natural laws. In reality, markets are social constructions whose rules are set by institutions and regulated by governments. ~ Oxfam International
The idea that buyers and sellers possess perfect information is theoretical tripe which everyday experience contradicts.
The difficulty of distinguishing good quality from bad is inherent in the business world and may indeed explain many economic institutions. ~ George Akerlof
Information asymmetry affects both pricing and quality, resulting in adverse selection: an economic transaction with inherent risk due to lack of information. Sellers know more about the quality of the goods they offer than do buyers. Hence, there is an incentive for sellers to offer lesser-quality goods than expected for the price (given cost and quality going hand-in-hand).
The situation in the market is complex. Whereas market leaders with esteemed brands gradually erode product quality and sometimes subtlety raise prices (e.g., same price, smaller portions), upstarts make their way up via better quality at lower prices. For both, information asymmetry is in play: working for the leader and against the upstart until reputations change. This is only one way that information asymmetry can be a powerful force in marketplace dynamics.
Consider a market in which goods are sold honestly or dishonestly; quality may be represented, or it may be misrepresented. The purchaser’s problem, of course, is to identify quality. The cost of dishonesty lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence. Dishonesty in business is a serious problem in underdeveloped countries. ~ George Akerlof
In the instance of health insurance, buyers know more about their health than does the insurance company. Insurers prudently assume something near the worst case, which inordinately raises the price for those in good shape.
Medical insurance is least available to those who need it most, for insurance companies do their own “adverse selection.” The principle of adverse selection is potentially present in all lines of insurance. ~ George Akerlof
Minorities have long suffered adverse selection in getting jobs. Governments in some countries, including the United States, have intervened to correct a heuristic for economic efficiency.
Employers may refuse to hire members of minority groups for certain types of jobs. This decision may not reflect irrationality or prejudice – but profit maximization. For race may serve as a good statistic for the applicant’s social background, quality of schooling, and general job capabilities. ~ George Akerlof
Simply put, markets are never efficient. Sellers charge as much as they can get away, and consumers buy what they must or can afford, all depending on individual needs and tastes, and availability at the moment.
The hoariest form of dynamic pricing was practiced in ancient bazaars, where merchants would size up their customers before the haggling began. Computerization has made dynamic pricing the norm.
From the early 1980s, airlines took to varying the price of their tickets to gouge their frequent business customers, as well as to fight competition from discounting upstarts. The practice soon spread to hotels, car-rental firms, and railways.
Dynamic pricing became all the rage when e-commerce became common. Competitors can be constantly monitored, and their prices matched. The US retailer Kohl’s holds sales that last for hours rather than days, pinpointing the times when discounts are most needed. Amazon updates its price listings every 10 minutes. Cintra, a Spanish infrastructure firm with toll roads in Texas, changes prices every 5 minutes so as to keep traffic moving. Tickets for sporting events, concerts, and even the zoo are dynamically priced, to maximize profits for hot tickets and to stimulate demand for unwanted ones.
Dynamic pricing both smooths demand and makes it easier to squeeze more from those with more to give. Travel web sites have experimented with steering Apple computer users, who are assumed to be better-off than plebian Windows users, to more expensive options. Airlines regularly charge their frequent customers more than those seemingly out on a lark, on the assumption that regulars are more likely to be on a work trip for which their employer pays.
Uber matches folks wanting a ride with contractor drivers who act as taxis. The company encountered a backlash when it jacked its prices 8-fold during 2013 storms in New York.
Such “surge” pricing makes perfect economic sense: drivers are more likely to go out into hostile conditions if they are paid more, and many needing to get somewhere would prefer a high-priced ride to no ride at all; but economic sensibility cuts little ice when it offends people’s sense of equity.
Psychological resistance can be fierce when companies use collated data against their loyal customers. In 2000, Amazon quickly scotched a scheme to charge more for video disks based upon personal profiles.
You really have to take that extra step and click through to the list of all sellers for a given product if you want to find the lowest price. ~ American computer scientist Christo Wilson
Online shopping is undeniably convenient. Hosting many sellers for its vast array of products, Amazon.com, the giant online shopping center, appears to offer the lowest prices. Instead, Amazon gives sellers a way to provide the illusion of competitively low prices while reaping non-competitive profits.
It may seem that Amazon lists sellers with the best prices for featured products; but that is not so.
When you go to a page on Amazon, what you’re seeing is typically not the lowest price available. ~ Christo Wilson
Most featured sellers use an automated pricing mechanism called algorithmic pricing, which adjusts product prices in real-time using computer algorithms. The algorithms are designed to reap any possible profit while probabilistically staying within the bounds that leave consumers likely to click the “buy” button.
Amazon has a relatively low number of algo sellers – from 2 to 10%. But they cover almost a third of the best-selling products offered by outside merchants, so the impact is large. ~ Christo Wilson
Such automated pricing may sound expensive to code, but it’s not, because Amazon brokers it to sellers as a subscription service for a fee.
60% of sellers using algorithmic pricing have prices that are higher than the lowest price for a given product. ~ Christo Wilson
Algorithmically determined prices are 10 times more volatile than those set by humans. It makes it very difficult to determine whether you, the consumer, is getting the best possible price. Come back in a few days, or even a few hours, and the price may be significantly lower. Or higher.
This is very much a winner-take-all system. If you’re that one lucky seller who gets the ‘buy box,’ you make all the sales. So if you want to be competitive for the top-selling products, you pretty much have no choice: you have to be an algorithmic seller. ~ Christo Wilson
If desire for goods increases while its availability decreases, its price rises. On the other hand, if availability of the good increases and the desire for it decreases, the price comes down. ~ Mesopotamian Islamic scholar Ibn Taymiyyah
As Ibn Taymiyyah mused in the 13th century, prices are set to maximize sales and profits. The price of a good solely reflects instant market conditions where its is on sale.
Market clearing is the process of supply meeting demand, which is theoretically done at the equilibrium price. For 150 years, from 1785 to 1935, the vast majority of economists took market clearing through the price mechanism to be inevitable and inviolate. This assumption was codified in Say’s law.
A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value. ~ Say’s law (1803)
French businessman and economist Jean-Baptiste Say thought that “a glut can take place only when there are too many means of production applied to one kind of product and not enough to another.”
Say’s law was held as gospel truth to economists until the Great Depression shook their faith that the free market necessarily ate what it made. During the doldrums of the 1930s economists struggled to explain how ruinously high rates of unemployment could persist for so many years.
Keynes was one of them. He and other economists suggested tinkering with the market, blithely assuming that the otherwise perfect price adjustment mechanism was somehow gummed up by government and could be fixed by government. Ironies never cease in economics.
As US President, FDR tried everything politically feasible that the economists suggested. The only thing that worked was going to war – the ultimate act of destruction.
The assumption of market clearing still reigns for macroeconomists studying long-term issues, such as growth. Market-clearing models are employed to characterize the equilibrium toward which an economy supposedly gravitates.
Macroeconomic market clearing is codified as Walras’ law, which is an updated version of Say’s law. Put forth by French mathematical economist Léon Walras in 1874, the law posits that the values of sectoral excess demand sum to zero.
Walras’ law has wide-ranging implications. In assuming an economy as zero sum, it axiomatically (and inscrutably) finds that an excess demand in one economic sector is balanced by an excess supply in another.
One facet implied by Walras’ law is that unemployment cannot be involuntary in a market economy with flexible prices and wages: an excess supply of labor will be mopped up by a fall in money wages – an utter fiction. The tidy equivalence found in Walras’ law has been embraced by macroeconomists, despite having no foundation in actuality.
Walras’ law is accepted as valid – indeed as irrefutable – by modern-day economists. ~ Steve Keen
Keynes thought these equilibrium laws were bunk: he argued that if consumption and investment were supposedly balanced via these principles, then falling demand for consumption goods should give rise to increased demand for investment goods. Instead, investment demand is driven by expectation of consumer demand. Thus a downturn dampens expectations, leading to a general slump, as illustrated by the Great Depression which Keynes struggled with (unsuccessfully, owing to his allegiance to capitalism, and thereby failing to see its fatal flaws).
Earlier on, Marx had rejected Say’s initial proposition that “every producer asks for money in exchange for his products only for the purpose of employing that money again.” Marx noted that Say asserted that no one in a market economy wished to accumulate wealth.
Over a period during which economic growth takes place, at least some sectors finance a part of their spending by emitting debt or selling assets. ~ Hyman Minsky
In the latter 20th century, American economist Hyman Minsky pointed out that Say’s and Walras’ laws were fallacious for failing to take into account credit and debt. Thus, sectoral demands never sum to an aggregate zero, nor is equilibrium ever in sight.
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Price does not act as an efficient market-clearing mechanism. Contradicting the spirit of his law if not the letter, Say observed that the market acts to overproduce, and then dumps the remainders at a loss while moving on. In other words, price spurs overproduction, which can cause cyclical price gyrations. This dynamic has been repeatedly observed in a wide array of products.
In a forward-looking sense, price guides investment to exploitation potential. This is the timeworn mechanism for how potential suppliers respond to price: as a signal for profit opportunity; whence oversupply. Efficient resource allocation is never in the offing via the price mechanism.
The single most significant factor in profitable pricing is alternative cost: what a consumer might otherwise have to pay to obtain an equivalent. If the same good may be had from another source – that is, under competition – it is a buyer’s market, and prices are (hypothetically) competitive.
Similarly, if a substitute good is available, that too is an ersatz form of competition. But a substitute is not selfsame: the desired product may be favored to some degree, and so can command a price premium.
Reputation sometimes figures in a price premium. In the 1st decade of the 21st century, Apple Computer became the darling of touchscreen mobile phones. Even though roughly equivalent phones were available, the Apple iPhone commanded a reputation ransom.
If an equivalent ware cannot readily be found elsewhere, a seller looking to maximize profit will demand as high a price as he thinks will still sell the good. In early 15th-century Europe, a pocket of peppercorns would be worth a fortune, as the spice was a rarity with no substitute.
Gyres of Waste
The persistent breakdowns of the capitalist economy can all be traced to a single underlying cause: the anarchic or planless character of capitalist production. ~ American economist Robert Heilbroner
Competitive enterprise is economic anarchy. Individual firms are guided solely by their perception of profitable opportunities, without regard to the economy as a whole. Isolated atomic decision-making ensures misallocation and waste. The reason this occurs is that the price mechanism does not support the rationalization of resource allocation. The price signal is a clarion bell lacking clarity.
Rising prices suggest unmet demand. For lack of coordination, individual companies react with investments to manufacture supply that, in the aggregate, exceed need. Wasteful oversupply bubbles is one of the most salient characteristics of capitalism.
Oversupply is a global problem. ~ Chinese politician and business executive Gao Hucheng in 2016
In the 19th century there were 2 episodes of overbuilding railways in the United States. The 1st caused the Panic of 1873. The 2nd caused the Panic of 1893.
In a milieu of huge enterprises and enormous fixed investments, such miscalculations or imbalances carry the potential of a major disruptive impact. ~ Robert Heilbroner
Toward the end of the 20th century, an advance in drilling technology (horizontal fracking) afforded extracting petroleum and natural gas from deposits previously considered uneconomic. A rush of investment led to a massive oil boom.
You’d be hard pressed to find anybody who saw this coming. ~ American economist Karr Ingham on the early 21st century oil boom in Texas
What no one investing seemed to see coming was the inevitable bust, causing the companies that had been so sanguine about the future to suddenly find themselves going broke.
When times are good in the oil field, no one ever thinks about the slowdown. But the slowdown’s always just around the corner. ~ American oil worker Jess Crone
The one surety of capitalism is that the lessons of history are never learned. An economic system driven by greed is instead guaranteed to repeat excesses which look rational only when viewed atomically, ignoring (or ignorant of) larger contexts, and with optimism: which is exactly how entrepreneurial decisions are made.
Besides the toll on the economy of such episodes, the price of such boom/bust cycles includes massive material waste and pollution, and large-scale dislocation in people’s lives. It is certainly no way to run an economy.