Principle #6: Markets work well with competition, the rule of law, information, incentives, and property rights.
Objectives:
Recognize that the price of a product only provides information if compared to other prices
Recognize that price is a unit of measurement reflecting the relative scarcity of a product
Distinguish rare from scarce
Why you want to learn this
You probably don’t appreciate being deceived. Well, that’s what prices can do to you if you take them at “face value.” You have been looking at a fancy camera and the price has gone up by 5% since you have been looking. During the same time, you earned a raise of 10% and you notice that your grocery bill and utilities have increased by about 12%. Has 2 was about the price of the camera really gone up. Well, yes in absolute terms, but no in relative terms. This phenomenon of changes in relative prices is one that you are going to want to consider in making purchasintheg decisions.
Relative price
When the word “price” is used in economics, the inference is that the price under discussion is the price of a product relative to all other products. In studying economic history, it is often frustrating when authors state the price of a product such as cinnamon or silk in ancient currencies and weights. For example, in 1284, a pound of mace cost 4 shillings 7 pence. That statement, by itself, is of no help whatsoever. If a further statement is added, “This sum could also buy three sheep,” we have a little more information. But the final piece of information that would help make di out of the original statement would be, “This would take a common laborer about three months to earn.” The point is that the first statement provides no information unless the reader knows the prices of other goods and services and the typical income of the consumer. Four shilling seven pence must be put in perspective.
The average price of a cell phone in 2022 was around $700, about half the price of a laptop. While average incomes vary from state to state and by different levels of education and other demographics, we can assume that the average annual income in 2022 was about $55,000. According to the Law of Demand, if the price of the phone falls, and nothing else changes, buyers will buy more phones. If however, the price of a cell phone doubles, at the same time that the price of all other goods and services and all incomes double, there is no incentive to change the amount of phones purchased. Only if the relative price of phones changes, is there a change in the incentives of c bell phone buyers and sellers.
Relative price and relative scarcity
You now understand how prices are determined. But do you know what a price is? Price is nothing more than a unit of measurement like inches, calories, degrees, hours and minutes, miles, etc. Relative scarcity is the relationship of supply and demand for one product relative to the relationship of supply and demand for another product. and it is measured by price. For example, top movie stars such as Brad Pitt or Penelope Cruz earn much more than others because the demand is so high relative to the supply.
The air is electric as people file into the crowded room. A newly discovered Van Gogh is up for auction and art dealers from all over the world have come to bid. Rumors of the discovery have been circulating for months, but most readers figure they are false and that the painting is a hoax. But here it is, validated by the finest art experts in the world, displayed on the podium, closely watched by two not so disguised security guards. What will it go for? Who will get it? The room is abuzz with speculation. The bidding starts at $2 million but quickly rises to $12 million. The final sale price is $15 million.
A young man goes into a hobby shop and wants to buy a famous baseball player’s rookie year baseball card. Two years ago he bought one for $20. The price today is $50. A student decides it is time to buy a computer. She goes to the electronics store to find that she can buy a computer with more memory, faster speed, and many more accessories than she would have dreamed of two years ago. And the price is lower than when she looked a year ago. It is not supply (sellers) alone or the demand (buyers) alone that determines relative scarcity; it is the interaction of supply and demand.
Relative scarcity depends upon both supply and demand. Even though every human being must have water to survive, it is not very scarce because there is lots of it. In the Sixties, people were buying “pet rocks.” They were ordinary rocks, cleaned, placed in a box, given a name, and sold. (Yes, people actually bought them!) Even though there are not many pet rocks around today, they are not scarce. The reason is not that there aren’t many, the reason they are not scarce is because there is no demand for them. The fact that they were relatively scarce at one time dramatizes the role of demand in the equation. The fact that there is a lot of a product or a little of a product does not, by itself, determine relative scarcity. The fact that lots of people want a product or only a few people want a product does not, by itself, determine relative scarcity. The prices of baseball cards, art, and old stamps and coins illustrate the determination of relative scarcity by supply and demand.
Price is not a measure of “worth” alone. A diamond is merely a shiny rock. While it has some commercial value, it is used mainly to adorn people. Insulin is lifesaving; without it, many people would die. And yet ounce for ounce, the price of insulin is far lower than that of diamonds. That would appear to make little sense. In some sense, insulin is more “useful” than a diamond. But price is not a measure of the usefulness of an item alone. Water is extremely useful, in fact, necessary for survival, but it has a very low price compared to gold. How is this possible? Isn’t insulin worth more than a diamond? Isn’t water of more use than gold? The confusion lies in the loose use of the words “worth” and “value” and the assumption that they are the same as price. Unlike “worth” or “value,” price is not a measure of the moral or social value of a product, it is the measure of relative scarcity.
Price provides a good deal of information about products. Rank the following items in terms of relative scarcity.
yacht
candy bar
laptop computer
mini truck
nice dinner for two in San Francisco
Without any information about supply or demand, you would probably rank the yacht as most scarce, followed by the mini truck the laptop, the dinner and the candy bar. You were able to rank the items because you had some idea of the relative prices of the items. The price of a product sends information to both buyers and sellers that this product is scarcer or less scarce than other products. Prices are helpful to sellers in that they provide information that allows them to make decisions about what to produce and how much to produce. Prices are helpful to buyers because they allow them to make subjective judgments about how much benefit they expect to get from the product, compare that to the price, and decide whether to buy or not to buy
Fair or Unfair
Prices are not fair or unfair. There are many units of measurement and changes in those measurements don’t usually cause public debate. When a teenager’s shoe size goes from 9 to 12 in six months, very few would declaim the fact as being unreasonable, unfair, ridiculous, or a rip off. When asked how tall she is, a woman might reply that she is 5”6’ and no one would rail against the fact, claiming that a plot had been hatched. If a recipe calls for two cups of flour, very few would claim that the recipe is a plot by the international flour conspiracy. If a worker lives 30 miles from home, people don’t usually picket the office, claiming that the distance is part of management’s plan to exploit the workers. If the temperature rises above 100 degrees, people may complain, but they are not likely to ask Congress to investigate the air conditioning industry. And yet that is often the reaction to price changes or prices that people don’t like. A price (in our case in dollars and cents) is the unit which measures relative scarcity. Neither shoe size nor price is a moral measure.
What may seem to be “unfair” is the fact that, in certain markets, a few sellers have some control over either supply or demand and, therefore, price. Many people dislike the existence of the Organization of Petroleum Exporting Countries (OPEC) and the fact that they attempt to manipulate supply, but that does not change the fact that the price of a barrel of oil reflects the relative scarcity of the product as determined by supply and demand. Others may rail against advertising agencies and the ways in which they attempt to manipulate demand for particular products, but that doesn’t change the fact that the price of a carton of lemon yogurt reflects the relative scarcity of lemon yogurt. The fact that those with market power (some control over supply or demand) may succeed in manipulating supply and demand does not change the fact that the price of the product reflects the relative scarcity of that product.
Rare vs. Scarce.
If a thing is rare that does not necessarily make it scarce; a rare tropical disease is not scarce. True, there is not much of it; but there is also little or no demand for it. A rare tropical fish, on the other hand, might be very scarce and command a high price if lots of people want it and are willing to pay for it. Rare describes how much is available, scarce describes how much sellers are willing and able to supply it compared to how much people are willing and able to pay for it.
Bottom Line:
Relative price is a unit that measures the relative scarcity of a product
Relative scarcity, and therefore price, is not determined by supply (sellers) alone or demand (buyers) alone; it is determined by the interaction of supply (sellers) and demand (buyers).
In a competitive market, price has no moral implications; it is neither fair nor unfair, sensible or ridiculous, right or wrong.
Rare and scarce are not the same.
1. Relative price of a product is a measure of the product’s
a. Worth
b. Moral value
c. Relative scarcity
d. Rareness
2. Relative price is determined by:
a. Demand (buyers)
b. Supply (sellers)
c. Both a and b
3. Which of the following is most scarce?
a. Two week vacation in Tahiti
b. Quart of milk
c. Skateboard
d. New car
4. Which of the following is least scarce?
a. Two week vacation in Tahiti
b. Quart of milk
c. Skateboard
d. New car
Use your knowledge of relative scarcity and price determination to respond to the following statements.
The price of chicken is ridiculous.
The salary of an NFL quarterback is immoral and unfair when people working for the minimum wage are starving.
I think I will become a doctor; they make lots of money.