Monday, 24 April 2017

Articles & Op-Eds

Let’s get back to basics. What is a price?

March 30, 2017

A price is an exchange ratio: you must give up a certain amount of one good in order to get another good.  Barter economies have prices, which are expressed as ratios of the goods themselves.  In money-using economies, prices are expressed in the economy’s medium of exchange, which frequently makes the medium of exchange the unit of account.  The fact that, in the U.S. economy, all, or nearly all, goods are priced in terms of dollars tells us that dollars are generally accepted to execute a transaction (that is to say, they are the medium of exchange). That is to say, dollars are the ‘language’ in which price tags are written, or the unit of account.

Of course, people know that prices are determined by supply and demand.  The interactive bargaining process between buyer and seller results in a price such that the additional benefits to consuming more units of the good equals the additional costs of bringing more units of the good to market.  All is well and good.  But we must also focus on the coordinative aspects of pricing an item.  Prices are ways of navigating trade-offs, such that people acting within the social-legal nexus called ‘the market’ can find ways of satisfying their wants without frustration.  This is usually interpreted as efficiency: maximizing the dollar value of society’s scarce resources makes everyone as well off as they can be.  But this conception of efficiency is a property of market models, not the market itself.  If we want to talk about existing market processes, we can talk about tendencies to efficiency, but in absence of a general competitive equilibrium, we need to find another way of expressing the value of a money-using economy and the system of prices it generates.

The most fascinating role that prices play, in my opinion, consists of helping traders move from subjective values to objective (or more accurately, intersubjective) exchange processes.  That is to say, where an apple is on my personal value scale cannot be translated into a universal measure of value apart from my particular evaluation.  But when I engage in a transaction with someone who sells apples, the price we agree upon helps us transcend purely subjective rankings in a way consistent with strict subjectivity. The transaction thus expresses the way we have each moved to a more preferred place on our value scales.  Indeed, the possibility of trading apples for dollars gives us a way of communicating with each other and coordinating our actions in a way that would not otherwise be possible as a generally accepted medium of exchange.  In a barter economy, we would only have particular exchange ratios for certain goods against others. whereas On the other hand, in a money-using economy, one market can more easily feed into all others, transmitting information and giving market actors a greater space to subjectively to pursue intersubjective coordination.

Why is said coordination good?  Economists tend to like it because it minimizes the number of people whose plans are systematically frustrated.  In broader terms, coordination provides a high degree of order in society, helping individuals cope with an uncertain future by giving them access to market data that helps them anchor their expectations.  This kind of order is spontaneous, not designed or imposed.  But it is order nonetheless.  Lastly, because new exchanges always result in the ‘churning’ of the market, there are always opportunities for entrepreneurs, guided by discrepancies in relative money-prices across markets, to ‘arbitrage’ across these markets by providing new goods and services in new ways, previously unanticipated in the market.

This has all been fairly straightforward market theory.  But this analysis has given us the foundation for asking a much harder question: to what extent is a money-using economy ‘unanchored’ from the baseline data—the current states of preferences, resource endowments, knowledge—of the market?  For example, are correct prices merely discovered, or are they both discovered and created by the act of market exchange itself?  If there is indeed a lot of ‘wiggle room’ in the system, can individuals unilaterally alter the terms of a transaction?  What about large firms?  What about the government?  We will explore these issues in my future posts.

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