Friday, August 04, 2006

The Source of Prices

The Source of Prices
by Ludwig von Mises

The ultimate source of the determination of prices is the value judgments of the consumers. Each individual, in buying or not buying and in selling or not selling, contributes his share to the formation of market prices. But the larger the market is, the smaller is the weight of each individual's contribution. Thus the structure of market prices appears to the individual as a datum to which he must adjust his own conduct. What is called a price is always a relationship within an integrated system which is the composite effect of human relations.

Money prices are exchange ratios. The divisibility of money, unlimited for all practical purposes, makes it possible to determine the exchange ratios with nicety.

Prices are determined between extremely narrow margins; the valuations on the one hand of the marginal buyer and those of the marginal offerer who abstains from selling, and the valuations on the other hand of the marginal seller and those of the marginal potential buyer who abstains from buying.

The valuations which result in determination of definite prices are different. Each party attaches a higher value to the good he receives than to that he gives away. The exchange ratio, the price, is not the product of an equality of valuation, but, on the contrary, the product of a discrepancy in valuation.

The characteristic feature of the market price is that it tends to equalize supply and demand. Any deviation of a market price from the height at which supply and demand are equal is — in the unhampered market — self-liquidating.

At times governments have resorted to maximum prices, at other times to minimum prices for various commodities. At times they have decreed maximum wage rates, at other times minimum wage rates. It is only with regard to interest that they have never had recourse to minimum rates; when they have interfered, they have always decreed maximum interest rates. They have always looked askance upon saving, investing, and moneylending.

But if the government fixes prices at a height different from what the market would have fixed if left alone, this equilibrium of demand and supply is disturbed. Then there are — with maximum prices — potential buyers who cannot buy although they are ready to pay the price fixed by the authority, or even a higher price. Then there are — with minimum prices — potential sellers who cannot sell although they are ready to sell at the price fixed by the authority, or even at a lower price. The price can no longer segregate those potential buyers and sellers who can buy and sell from those who cannot. If the authority does not want chance or violence to determine the allocation of the supply available, and conditions to become chaotic, it must itself regulate the amount which each individual is permitted to buy. It must resort to rationing.

Before the government interfered, the goods concerned were, in the eyes of the government, too dear. As a result of the maximum price their supply dwindles or disappears altogether. The government interfered because it considered these commodities especially vital, necessary, indispensable. But its action curtailed the supply available. It is therefore, from the point of view of the government, absurd and nonsensical. A government can no more determine prices than a goose can lay hen's eggs.

If the government is unwilling to acquiesce in this undesired and undesirable outcome and goes further and further, if it fixes the prices of all goods and services and obliges all people to continue producing and working at these prices and wage rates, it eliminates the market altogether. Then the planned economy, socialism of the German Zwangswirtschaft pattern, is substituted for the market economy.

Prices are by definition determined by peoples' buying and selling or abstention from buying and selling. They must not be confused with fiats issued by governments or other agencies enforcing their orders by an apparatus of coercion and compulsion.

Prices are a market phenomenon. They are generated by the market process and are the pith of the market economy. There is no such thing as prices outside the market. Prices cannot be constructed synthetically, as it were.

The very idea of cost prices is unrealizable. The reason why the price of Burgundy is higher than that of Chianti is not the higher price of the vineyards of Burgundy as against those of Tuscany. The causation is the other way around. Because people are ready to pay higher prices for Burgundy than for Chianti, winegrowers are ready to pay higher prices for the vineyards of Burgundy than for those of Tuscany.

Prices of the market are the ultimate fact for economic calculation. Attempts to eliminate monetary terms from economic calculation are delusive. No method of economic calculation is possible other than one based on money prices as determined by the market.

The pricing process is a social process. It is consummated by an interaction of all members of the society. All collaborate and cooperate, each in the particular role he has chosen for himself in the framework of the division of labor. Competing in cooperation and cooperating in competition all people are instrumental in bringing about the result, viz., the price structure of the market, the allocation of the factors of production to the various lines of want-satisfaction, and the determination of the share of each individual.

Ludwig von Mises (1881-1973) was dean of the Austrian School. This essay is based on Chapter XVI of Human Action, a text prepared by George Koether that appeared in The Freeman in 1981.

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