Displaying ignorance is seldom a good thing

Last week I wrote an article titled, "Bait and switch" prices are still going strong".  In it, I made this statement:

What's more, many of the prices charged for goods bear no relation whatsoever to the actual cost of production of those goods - another con game.

I was immediately pilloried by various commenters, both here and on Instapundit (which linked to the article).  A common reaction was to describe that statement as "socialist", and to decry any linkage whatsoever between cost of production and selling price.  I was publicly attacked for my "ignorance" on some other blogs (although I note with some cynicism that when I attempted to post a comment replying to such attacks, that comment was seldom published).

However, those disputing my statement were, in fact, displaying their own ignorance on the subject.  I think it deserves a short explanation, for their sake if nothing else.  BTW, my "credentials" in this discussion are that I've studied economics at undergraduate and graduate level.  I don't consider myself an "economist" in professional terms, but I know enough about the subject to consider myself economically literate at a businessman's level.  I'm not just sucking this stuff out of my thumb.

To begin with, cost of production is only one of many factors that affect the price of an item.  There's an entire field of economics dealing with the subject, and it would be impossible to summarize it here.  For those interested in reading more, try one or more of these sources:

• The Theory of Price (a brief introductory primer)
• Price Theory in Economics (a longer article;  link is to an Adobe Acrobat document in .PDF format)
• Price Theory: An Intermediate Text (an online edition of a textbook on the subject;  also an Adobe Acrobat document)

There's a fundamental relationship between what something costs to produce, and the price for which it's sold.  Basically, any businessman wants to make as much money as possible off each product:  but he's constrained by reality.  If he's selling it for, say, a hundred times what it costs him to make it (or buy it from someone who makes it), he's seemingly sitting pretty:  but every other businessman out there will notice that sort of profit margin.  Before long, they'll be selling similar products and undercutting him on price.  In other words, he has to set his price at such a level that the profit margin doesn't tempt others - or, at least, too many others - to enter his market.  The cost of production or acquisition is therefore an indispensable consideration (although, as stated above, not the only one) in the price of that product.

There's also the factor that excessive profit will attract public objection, and possibly political and regulatory intervention.  The past few years have provided some high-profile examples.  Consider, for example the scandal over the soaring price of Epipens, or the fury over the increase in price of Daraprim, both long-established medicines.  In both cases, the cost of production of the product concerned (tiny in relation to what consumers were expected to pay) was repeatedly cited in objections to their outrageous and egregious price increases.  Attempts by executives of the companies concerned to explain their actions went nowhere fast.  Both instances were very clearly "profit grabs", and the public and politicians saw through them and demanded action.  Any business trying to price its product at such excessive levels can expect such pushback, from the buying public at least, and possibly from the authorities if customers make enough fuss about it.  They will, if it's important enough.

Consider also the laws against price gouging passed in several states, that prevent businesses from raising prices on their existing stocks of critical items (e.g. fuel, emergency food supplies, etc.) during an emergency.  One can argue that such laws are misguided, because such increased prices serve to balance the (extremely limited and temporarily irreplaceable) supply with the sudden, vastly increased demand for it;  but that's beyond the scope of this article.  Suffice it to say that the reason such laws were passed is because consumers in those states knew full well that some businesses were making a fortune by charging vastly more for their stock in trade than it had cost them, and they resented it.  That resentment translated into passing laws to prevent and/or punish such profiteering.  Like it or not, the price of the article was legislatively linked to its input cost/cost of production, and that remains the law in those areas to this day.  I don't see it changing anytime soon.

"Pure" laissez-faire economics would certainly postulate that there should be no linkage between the cost of production of an item, and its selling price.  However, there is no such thing as "pure" laissez-faire economics, anywhere in the world.  It's no more than a theory, a pipe-dream, in precisely the same way that "pure" libertarianism would be completely unworkable as a means of running society.  There have to be checks and balances on the "purity" of both concepts, lest their "perfect" theory should run headlong onto the rocks of practicality in day-to-day life.

One such "check and balance" is the concept of a moral and/or ethical price.  Every major religion in the world, and most developed philosophies of life, embody, directly or indirectly, considerations of what is just and unjust in economic terms.  That includes the pricing of goods for sale.  It's generally considered unjust to set an excessively high price for necessities in terms of their actual cost, because people will suffer without them.  Their cost figures into what is considered a "fair" or "just" profit margin in pricing them.  For example, usury (the lending of money at excessive rates of interest) was (and still is) generally condemned as wrong, even sinful.  The modern version of an usurer, a loan shark, is considered a criminal in terms of many civil laws based on such norms.  The Epipen scandal referred to above was said to have "crossed ethical boundaries".  There are many other examples.  Such moral and ethical (and sometimes legal) constraints are a fact of life when setting a product's selling price, and we ignore them at our peril.

I'm not going to waste your time by going into more detail here.  I've provided sources you can read if you'd like further information.  However, let me close by reiterating that its production cost is inextricably linked to the selling price of a product.  That's not socialism, although socialists like to claim it as one of the tenets of their philosophy.  It's basic economic reality.  There are many other factors affecting price, to be sure:  but production or acquisition cost is unquestionably one of them.

Peter