What Are Just Prices?

by Jeffrey Tucker - May 21, 2008

Reprinted with permission.

We all have strange and contradictory wishes concerning what prices should be. We are outraged at what is happening to the price of gas and food. We don't think they should go up. In real terms, we want them to fall, and they have fallen in the last decade and a half. That's a good thing, right? That's how the world should work.

But housing? Now, that's a different matter. When the prices fall, people freak out. It's like the end of the world. How is it possible that my own home would fall in price? That's not the way the world should work! Everyone knows that house prices are suppose to go up, up, up – always, without fail, until the end of time.

Same with stocks. We want to open the Web page that lists our portfolios and see the prices higher and higher all the time. When they fall, we flip out and demand justice.

But let's stop and think about how peculiar this is. What kind of theory of the world insists that houses and stocks always go up in price, whereas gas and grain always go down? That doesn't really make sense. A price is not set by natural law, nor are price movements intended to follow a preset pattern like the movements of stars. They are nothing but exchange ratios – points of agreement between buyer and seller. They reflect many factors, none of them fixed parts of the universe.

So why do we expect some to rise and some to fall? It all depends on whether you are in the position of a producer or a consumer. As homeowners, we are in fact "producers" of our home – that is to say, we are holding it with the expectation of someday offering it for sale. The same is true of our stocks. We own them, so of course we want the price to go up. Then we can sell them at a profit.

On the other hand, with things we intend to buy – things like gas and grain – we want the price to be as low as possible. We want the price to fall. That way we save resources.

So what's at work here is self-interest. Think of the same situation from the point of view of someone who is a first-time house buyer. Does this person want high prices or low prices? Of course the answer is obvious: He wants the lowest price possible, so for him this "housing bust" is not a bust at all. It is a boon. But once this person becomes a homeowner, matters change. Now he wants prices to rise.

Think of the gas-station owner. If it didn't affect how much he sold, does this person want prices to rise or fall? Of course he wants the highest prices possible.

I recall once dickering with one of those insufferable car salesmen. I had my eye on some car and I said I couldn't afford it. He asked me how much I wanted to pay for this car. I said $0. He looked at me like I was crazy, but I was only telling the truth. I added that I know how much he wants me to pay: a trillion dollars. And he reluctantly agreed. So how does the person who wants to pay $0 and the person who wants to get $1 trillion come to agreement? You find some meeting point in between, the point at which the car is worth more to me than the money I will give for it, and the money I will give for the car is worth more to him than the car. The resulting terms are called the price.

It's the same in all markets. We can see that it is perfectly absurd to attempt to fashion national policy around the interests of only one party to an exchange. To try to keep house prices high and rising cheats the first-time buyer. To keep them low cheats the current owner. To keep grain prices high helps grain producers but hurts grain consumers. Some gas companies might like high gas prices, but consumers hate them. On the other hand, gas prices forced lower by dictate might thrill consumers, but producers might end up hurting so much that they shut down. That helps no one.

The only real answer here is to let the free market rule, which is another way of saying that people should be free to come to their own negotiations about the prices they are willing to pay for this and that. Those points of agreement should be as flexible as human valuation itself. That is to say, we should be free to change our minds, with each exchange taken as an end in itself, with no bearing on future points of agreement.

This is not only fitting with the needs of freedom – any attempt to force prices to do this or that does in fact impinge on our freedom to negotiate – but it is also essential to a well-functioning economy. That's because the prices are heavily influenced by factors such as resource availability, the subjective valuations of consumers, and the profitability of the undertaking in light of accounting costs. In the end, the books have to be in the black. The prices that are accepted in the market must sustain this state of affairs. Even in mega-industries like oil, the difference between revenue and expenses can be surprisingly thin. Even small regulatory and tax changes can drive companies of all sizes to bankruptcy.

Prices are crucial to the wise apportioning of resources in a world with unlimited wants and limited needs. Prices affect the way in which we use things, whether conserving them or throwing them away. You will note that higher gas prices change the way you make judgments about going places and doing things. This is a good thing. They signal the need to conserve – and without unworkable mandates from government. And from a producer's point of view, prevailing prices provide crucial information concerning the forecasting of future profits, and hence today's investment decisions.

Now we must address the matter of justice. We think we know what a just price is, but do we really? And what actually constitutes justice in prices? What comes first to my own mind is the Parable of the Treasure in the Field. An unknowing landowner is just living day to day with no knowledge that there is a treasure in the backyard. Some other guy, however, has knowledge of the treasure, so he sells everything he has, knocks on the owner's door, and nonchalantly says, "You know, I would be glad to buy your property." The owner sells.

But let's be clear here: The owner did not know that there was a treasure back there. Nor did the buyer say a word about it, lest the price he had to pay go sky high. Today, people might say that the owner got ripped off. But Jesus doesn't say this. He holds up the buyer as wise and moral. Interesting, isn't it? Is there justice in this exchange? Most certainly. And why? Because they agreed voluntarily. That's all there is to it.

There is no way to observe an existing price and declare it just or unjust. As St. Bernardino – a shrewd observer of economic affairs – said: "Water is usually cheap where it is abundant. But it can happen that on a mountain or in another place, water is scarce, not abundant. It may well happen that water is more highly esteemed than gold, because gold is more abundant in this place than water."

The Late Scholastics, followers of St. Thomas Aquinas, all agreed that the just price has no fixed position. It all depends on the common estimation of traders. Luis de Molina summed up the point: "A price is considered just or unjust not because of the nature of the things themselves – this would lead us to value them according to their nobility or perfection – but due to their ability to serve human utility. But this is the way in which they are appreciated by men, they therefore command a price in the market and in exchanges." (For more on the views of the Schoolmen on prices, see Faith and Liberty: The Economic Thought of the Late Scholastics, by Alejandro Chafuen.)

Now, there are ways for a price to become a matter of injustice. It can mask fraud. The prices can result from or be influenced by some act of force, such as price controls or taxation or restrictions on supply and demand. Behind each of these we find coercion, a body of people who are mandating or restricting in a way that is incompatible with free choice. Arguably, this is not just.

We can conclude, then, that to the extent we complain about unjust gasoline prices, we need to look at the restrictions on refineries or exploration or drilling, or examine the role that high gas taxes have in pushing up prices beyond that which they would be under conditions of free exchange.

And as for those who believe that all prices should move in ways that benefit their own particular economic interests at the expense of everyone else, don't confuse your agenda with a matter of justice. Prevailing prices in a business-based economy are a reflection of cooperative arrangements involving people with free will.

Jeffrey Tucker is the editor of Mises.org. Contact him at tucker@mises.org.