By Dr Frank Shostak
Some commentators are of the view that an important driver in the increases of the prices of goods is businesses that push prices higher in order to secure higher profits. According to the Ground Work Collaborative think tank report,
Prices are simply the sum of costs and corporate profits. While rising costs of inputs can drive up what Americans pay at the gas pump or the grocery store, corporate profits can just as easily.
The report, found corporate profits accounted for about 53% of inflation during the second and the third quarter of 2023. But does it make any sense that profits cause price inflation? We suggest that businesses cannot raise prices to secure higher profits without the buyers’ agreement.
We hold that the price is the result of buyer’s assessments at a given point in time of the facts of reality in accordance with each buyer’s particular end. Here is why.
How prices are established?
As a rule, a supplier sets the price. After all, it is the supplier who offers the goods to the buyers. So it is the supplier who must set the price of a good before he presents the good to the buyers.
In order to secure the price that will improve his lot, the price that the supplier sets must cover his direct and indirect costs and provide a margin for profit. By setting the price, the supplier must make as good an estimate as possible whether he will be able to sell his entire supply at the price set.
The process of making the estimate involves the assessment of the possible responses of the buyers and the possible responses of his competitors — other suppliers. If his estimates are accurate then he makes a profit.
Notwithstanding that the supplier sets the price, the final decision maker of the price of goods is not the supplier but the buyer. It is the buyer by accepting the price that is set by the supplier that determines the goods price. The supplier in the market is at the mercy of the consumer i.e. the buyer. This means that the supplier cannot raise prices in order to raise his profit without the consumer’s agreement. Entrepreneurs and producers are essentially servants of the consumers, as their success depends on their ability to anticipate and satisfy consumer needs.
In a free market, consumers “vote with their dollars.” With every purchase, they are signalling to producers what goods they want and in what quantities, ultimately directing the entire structure of production. According to Ludwig von Mises,
The state of the market at any instant is the price structure, i.e., the totality of the exchange ratios as established by the interaction of those eager to buy and those eager to sell. There is nothing inhuman or mystical with regard to the market. The market process is entirely a resultant of human actions. Every market phenomenon can be traced back to definite choices of the members of the market society. The market process is the adjustment of the individual actions of the various members of the market society to the requirements of mutual cooperation. The market prices tell the producers what to produce, how to produce, and in what quantity.
Observe that while the cost of production in some cases would appear to be the main factor in price determination, this is not so. Ultimately, it is the evaluation of the buyer that dictates whether the price set by the supplier is going to be realized. Every buyer decides in his own context whether the good that he bought at a particular price betters his life and well-being.
If the cost of production were the driving factor behind the setting of the market prices, then how would we explain the prices of goods that have no cost because they are not produced — goods that are simply there, like undeveloped land?
Likewise, the cost-of-production theory cannot explain the reason for the high prices of famous paintings.
According to Rothbard,
Similarly, immaterial consumer services such as the prices of entertainment, concerts, physicians, domestic servants, etc., can scarcely be accounted for by costs embodied in a product.
It follows then that businesses striving to make profits cannot increase the prices of goods without the agreement of consumers.
Defining what price is
A price of a good is the amount of money paid for the good, such as the number of dollars per a loaf of bread or the number of dollars per shirt. The key driving factors here are the amount of dollars and the quantity of goods.
Now, within all other things being equal, an increase in the amount of money paid for goods implies that the price of these goods is going to be higher. More money is likely to be paid for these goods.
In the absence of the increase in the quantity of money there cannot be a general increase in prices, all other things being equal. If a business raises the price of its goods and consumers have agreed to this increase then consumers are going to have less money to spend on other goods, all other things being equal. Hence, we will have here a specific price increase but not general increase in prices.
Increases in money supply is what inflation is all about
By a popular thinking, it is the role of the central bank to guide the economy onto the path of economic and price stability.
If central bank officials form a view that the economy is likely to fall to below the path of economic and price stability, then officials are expected to prevent this decline through an expansive monetary policy.
We suggest that an expansive monetary policy cannot generate economic stability. The expansive monetary policy sets the foundation for an exchange of nothing for something, or the diversion of wealth from wealth generators to the early recipients of the newly increased money supply. As a result, this undermines the process of wealth generation and weakens the prospects for economic growth.
As a rule, because of the increases in the money supply on account of the expansionary monetary policy of the central bank, individuals are going to have more money in their pockets, which they are likely to dispense with by buying goods. This means a greater amount of money is going to be spent on various goods. Hence, we will have now more money per goods i.e. the prices of goods are going to increase, all other things being equal.
As a result of the increase in money supply producers’ costs follow suit. This however, does not imply that the cost of production sets the goods prices. The prices are still determined by the buyers. Note that as a result of the increase in the cost of production, suppliers are going to set higher prices, which they are then going to present to the buyers. Within all other things being equal the buyers with a greater amount of money in their possession are likely to agree to pay more money per unit of goods – i.e. to an increase in prices.
Hence, the increase here in the prices of goods is not because of the increase in the production cost but on account of the fact that consumers now have a greater amount of money in their possession.
Could price controls resolve the issue of general price increases?
Many believe that the government should introduce price controls in order to prevent increases in the prices of some key consumer goods. However, a policy of restricting price adjustments because of the expansionary monetary policy is going to weaken various marginal producers. Consequently, these producers are likely to move to other activities, which are not subject to government price controls.
As a result, the supply of some key consumer goods is likely to come under pressure. So rather than benefiting consumers the government policy is going to hurt consumers’ well-beings. A policy of price controls is likely to increase shortages and the stifling of the production of goods and services.
Conclusion
Some commentators blame businesses for pushing overall prices higher in order to boost their profits. Whilst businesses set prices it is the consumers that determine whether the price set is going to be accepted. The suggestion by some that there is a need to impose price controls on some essential consumer goods is likely to stifle the production process, if implemented. This in turn is likely to produce shortages and a decline in the living standards of various individuals that the government wants to benefit. Furthermore, note that the major cause behind the increases in prices is not corporate profits but the expansionary monetary policy of the central bank.
