Wednesday, April 09, 2008

Economics: price and competition

Part I: Value and Cost

See the Proviso.

In the previous post, we talked about various abstract products: Everything costs $1.00 to make, but the abstract products have different inherent values:
  • widgets: $2.00
  • gizmos: $1.60
  • doodads: $1.50
  • geegaws: $1.40

We know we have to pay the widget makers only $1.40 per widget to keep them from making lower-value geegaws, but how much should we charge for a widget?

If we make the inherent value the price, then we start off selling widgets for $2.00 each, gizmos for $1.60 each, etc.

But of course the gizmo makers are going to think, "Hey! We can make widgets instead of gizmos, and charge only $1.90 for them!" Of course, the original widget makers realize this, and they can drop the price as well. Eventually, competition will push the price of widgets to the inherent value of the next most valuable thing. So widgets will sell for $1.60, the same as gizmos.

Of course, the doodad makers have the same thoughts, which pushes the price of gizmos and widgets down to $1.50. Since everyone is busy making widgets, gizmos and doodads, there's no reason to pull the cost down to the level of the geegaw. But when we expand our labor pool and have the ability to make even lower-value products, eventually the actual cost will reduce to just above the true cost, and the actual profit will reduce to just above the actual cost.

Competition will reduce the price of all products to the inherent value of the lowest-value product actually made.

Which means the actual profit, the price minus the cost, will be the difference between the inherent value of the lowest-value product being made and the inherent value of the highest-value product not being made. Eventually, if I can buy a widget for $1.02, $0.01 of the excess value goes to the widget producers, $0.01 goes to the actual workers, and $0.98 of goes to the consumers.

In a truly free market economy (i.e. an economy where coercion is arbitrarily ignored) almost all of the excess value goes to the consumers, not the producers.

Free market economics tends towards Communism.


  1. You're assigning these items different inherent values, but you are otherwise treating them as if they were absolutely interchangeable, with no reason for consumers to prefer a widget over a geegaw, or vice versa, except cost. If they are interchangeable, how can they have different inherent values?

  2. Hmm? How am I treating them as interchangable? I'm treating only the workers as interchangable. That's why the gizmo makers would have to charge only $1.90 for widgets to compete, because people will buy only 1,000 widgets.

    The differing value measures the non-interchangability of the items: Given the same price, a person will choose a widget over a gizmo until the demand for widgets has been satisfied, and only then will she start looking at gizmos.

  3. They're actually competing because you can't just make 3,000 widgets; only at 1,000 is the (statistical) inherent value $2.00.


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