Sunday, April 18, 2021

How The Things Are Priced

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First, prices are always relative. We value article say 1 more than we value article 2 and some other person values article 1 less than he values article 2. They will exchange the goods till their total valuations become more than they were before exchange. Prices are the point at which total valuations become equal for both the individuals.

Let us recall Ricardo’s Law of Comparative Advantage

Ricardo’s law was framed for international trade, but it is equally true for two individuals also.

Suppose there are two persons A and B. A produces 10 pieces of Article 1 in one day and produces 8 pieces of article 2 in one day.

B produces 4 pieces of article 1 in one day and 7 pieces of article 2 in one day.

Both work for two days and each produces both articles.

A = 10 and 8

B= 4 and 7

Total article 1= 14, article 2=15 Total production 29 pieces

At the end of two days, A will have 10(1)+8(2)= 18 articles and his satisfaction is S1A
At the end of two days, B will have 4(1)+7(2)=11 articles and his satisfaction is S1B
If they divide the production and on both days A produces only article 1 and B produces only article 2

Then A= 10+10= 20

B= 7+7= 14

Total production 34 articles(>29). If they so divide the articles that A has x(1)+y(2)=z articles and his satisfaction is S2A and B has a(1)+b(2)=c and his satisfaction is S2B (with the condition that a+x is 20 and y+b is 14 and c+z=34). Then they will exchange their products in a ratio (that is, values of x,y,a,and b) will be such that S2A>S1A and S2B>S1B and the number of 1 with respect to 2 is their relative price (that is, how many 2s A wants for his 1s and how many 1s B wants for his 2s (and prices are always relative.) This is the only basis of prices. Prices of even large number of goods with large number of persons in the markets are arrived through this process only, though to a casual observer prices may seem pre-existing.

The two persons working together have become more productive (34>29), that is, productivity per capita has increased for the society of these two persons as a whole.

So, the total production has increased by the division of labour. This happened even though A was more productive in both the articles than B. This holds true for two individuals, two households, two villages, two cities, or two countries, and for very large number of commodities and for large number of individuals. Total production will always increase when each produces only what he is better at among his various skills, instead of producing everything himself.

Division of labour assumes that production of each of them is safe, and they are free to trade, because they will need to trade their produce and buy what they do not produce themselves. And this freedom includes deciding the prices, that is how many of 1s will be exchanged with how many of 2s.

Cities always continue to grow in size because they facilitate division of labour. Trade is essential because only it makes division of labour possible.

And you can see that S1A and S2A and S1B and S2B are subjective, therefore no bureaucrat can ever decide price, and if he uses government’s gun to do so, S1A and S2A and S1B and S2B will be different from what the individuals wanted, and therefore their satisfaction will be different from what they wanted and hence their production will start decreasing and will eventually reduce to subsistence levels. This is borne out by the decline of all government-price controlled economies.

It is also clear that B can’t insist that he will produce article 1 and not 2. So each individual is forced by the market to produce what others lack, not what he wants. Otherwise he can go back to homestead and live out of market. And societies without market are the poorest societies on earth. The individuals who do not participate in the market are always the poorest in any society.

So, pursue your dreams by all means possible, but make sure you also produce something what others want, otherwise you will only have dreams, not breads. And if your dreams coincide with what others want, well, you are lucky, you have won the lottery of life.

And of course, do not, never, demand that government should control prices. You will destroy your future, and future of your children, your society, your country.

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