Price System

The main idea presented in this chapter is that any economy’s effects are better analyzed by the long run rather than immediate results; by the secondary consequences, not primary; the effects of all people but not of a group. This chapter discusses how the price system solves the problem of alternative applications of capital and labor to meet lots of needs and wants of various urgencies in a society. The paper argues that there are many economic erroneous beliefs that arise as a result of thinking about an  industry or some process in isolation as the determinant of the economy. These fallacies go beyond not only the arguments of advocates of specific interests, but also even some insightful economists.

One of these fallacies is the fallacy of isolation which is common for the production-for-use rather than production-for-profit school of thought. The adherents of this school attack on what they believe as nasty “price system”. The problem of production, they say, is solved. Most groups have tried solving it; the engineers, technicians and the efficiency experts have used too many resources and time. However, the world economy is ruled by businessmen thinking of how to make profit, not the engineers and other parties who only think of the production process. This article further says that a strong economy is business-man driven; it is one in which the businessmen will give orders and advise the engineers what to produce since the businessman knows what consumers want and how they want it to be made. It should not be vice versa.

A businessman turns out any trade of items whose sale is associated with profit; the moment there will be no longer a profit from making the product, he stops making it regardless of whether consumers are satisfied or not and whether or not the world is yearning for more goods. So many fallacies exist in this school that entangling them at once is not easy. The central error, however, comes from looking at a single industry, or several industries in turn assuming that each of these industries existed on their own in isolation. As a matter of fact, each industry exists in relation to all the other ones and, thus, every decision made in a particular industry affects th other ones and is also affected by the decisions that are made in the other industries. One would understand this better if he/she understands the basic problem that business has to solve collectively. A good example provided is that of a Swiss family Robinson. The family has many mouths to feed and at the same time more hands to work for it. Therefore, this family can practice specialization and division of labor. The family, however, cannot make it have one of its members performing one task endlessly, regardless of the urgency of what he supplies and of the other unfulfilled needs They are rather sent each to a different duty like fishing, sawing and so on. At the end of the day, many activities will have been done and the family enjoys dinner together. This is an example of how an isolated member in the family or one occupation in business can only expand at the expense of other occupations.

The second part of the Chapter 15 explains the modern society. It answers how the problem of alternative applications of capital and labor to meet the enormous needs and wants of different urgencies is solved in this society. The answer lies in the price system by constantly changing the inter relationships of the costs of production, their prices and profits. Price is determined through the relationship of demand and supply which in turn affects demand and supply. People will offer more for an article if they want more of it. Its price rises which, in turn, increases the profits. The increase in profits motivates businessmen to make more production while more people are attracted to the business. Supply increases, price reduces and, consequently, the profit margin reduces until the article’s profit margin falls to the general level of other industries.

Moreover, the demand of the product may fall or the supply may increase to a point where the price will fall to a level where it will experience less profit in making it than making other products. It can also be a loss making it. In that case, the marginal less efficient producers, or those with high costs of production are driven out of business. The price of a commodity is not determined by the cost incurred in producing it; it is the present relationship of supply and demand. It, therefore, falls in relating to the price of other products, and the product’s production relatively disappears. That also means that if the demand decreases, the price goes lower, and production of the product declines; that is how the price system works.

For an economy at equilibrium, an industry can only expand at the expense of others. When one industry shrinks, it does not mean that there is any net decline for the aggregate production. The shrinkage of the industry may be a decent chance for the rest to increase their production. Therefore, everything is produced as a result of foregoing something else.

In conclusion, the costs of production are those things we forego in order to create what matters, such as pleasures, raw materials and leisure. To maintain the health of a growing economy, dying industries should be encouraged to do so as they release labor to be absorbed into the growing industries. The price system is the only thing that can solve the much complicated problem of choosing what services or products should be relatively produced. The complicated problems are well solved by this system of prices, costs and profits better than by any other group of professionals.