RALEIGH — How much is a gallon of water worth?
The answer to this question reveals much more than one’s knowledge of today’s prices. It is the key to understanding the economic way of thinking. And it helps to explain why current efforts in the North Carolina General Assembly to ban “price gouging” after natural disasters are such a bad idea.
Believe it or not, the philosopher Aristotle was stumped by this seemingly simple question. He observed that water was a necessity of life, yet it was usually considered less valuable than, say, precious metals with little practical value. He distinguished between the value of a product in its use (drinking the water) and the value of a product in exchange (its monetary price or usefulness in barter). But he was unable to reconcile these, or to make sense of why some things command higher prices than others.
The father of classical economics, Adam Smith, also struggled with the issue. His solution to the “water-diamond paradox” — why a given volume of diamonds is worth far more than a given volume of water, even though the latter is more useful — was that diamonds were relatively costly to find and mine, whereas water was easy to find. In other words, he advanced a theory of value based on the cost of production, a theory advanced and refined by other economists of the 18th and 19th centuries.
One of these, Karl Marx, discarded the general concept of the cost of production to zero in on the idea that a good or service is worth only as much as the labor expended to produce it. In this way, he was able to argue that any proceeds from the sale of the good not paid to the workers was the result of capitalist exploitation.
Stay with me, now. I’ve almost worked my way back to the General Assembly and price-gouging.
All of these cost-of-production ideas and labor theories of value were, in the end, rocky roads leading nowhere. None was able to explain fully why a gallon of water cost what it did. Only in the 1870s, with the simultanous discovery of marginalist economics by William Stanley Jevons in Britain, Leon Walras in Switzerland, and Carl Menger in Austria, did economists finally figure out that prices aren’t determined catagorically. Diamonds don’t inevitably and always cost more than water. The only way to understand price is at the margin — at the point where individual producers and consumers are producing and exchanging the next individual unit of output.
Imagine a man stumbling out of the desert, half-mad, starving and dying of thrist. If offered a diamond or a glass of water, which is he likely to value more at that time? Later, satiated and partially recovered, won’t his preference change again? In less extreme examples, prices shift constantly and differ from buyer to buyer. Prices are relative, not fixed. There is no paradox to resolve, as there are no stable relationships between prices separate from the context of production and consumption by individual human beings at specific points in time.
These marginalist theories weren’t identical. Jevons, whose followers went on to found the Neo-Classical School of Economics, argued that prices are determined at the point where producer supply and consumer demand intersect (generating the famous “scissors” diagram of alternately sloping supply and demand curves). Menger and the Austrians, on the other hand, essentially denied that cost was part of the equation at all, contending the consumers acting subjectively always determine value in comparison with alternative choices (what is called “opportunity cost”).
Still, once the marginalist revolution came along, only those with an unexamined sense of how economics works still believed that prices were simply determined by how much capital or labor was expended to make a good. As I’ve observed in this space before, even a ditchdigger has a better understanding of economics than that. He knows that if he spends a hour digging a ditch, and another man spends four hours digging and filling in and then digging the same-sized ditch, the latter’s work isn’t worth four times as much as the former. They are worth the same.
And now, price gouging. Currently, North Carolina lawmakers are fumbling around in their attempt to define it, and thus to ban it. The problem is, of course, that there is no fixed and stable price for anything, water and generators included. After a storm, if water and electric service are knocked out, gallons of potable water and gas-driven generators are really worth more, often much more, than they were before the storm, regardless of the fact that their cost of production is unchanged. Sen. A.B. Swindell, a Democrat from Nash County, has said that gouging should be defined as raising the price of staple goods by more than 10 percent immediately after a disaster. Why not 5 percent? Why not 15 percent? This is just nonsense.
There happens to be a sound free-market reason why many businesses don’t reset all their prices upward during emergencies, even though they might properly expect desperate consumers to pay the prices. They know that the emergency will pass, and customers often have long memories and alternative places to shop.
But in other circumstances, rising prices are not only inevitable but also play an important role in disaster recovery. Soaring prices for generators in the wake of a storm serves to re-route stocks of generators to the communities where they are most needed. Similarly, a higher wage available to tree-removal and repair workers in a disaster area serves to entice other contractors, sometimes from far away, to speed to the scene to pick up extra business. Finally, the memory of higher prices during emergencies can induce consumers to plan ahead for the next one by buying a generator or stocking up on essentials, thus alleviating their suffering in a future disaster.
There’s no point ranting and raving against this. There’s certainly no point passing laws against it. Scarcity and consumer demand are facts of economic life. Prices are an indispensable means of communicating economic information. And economic decisionmaking is a part of human nature. On the other hand, at least our state legislators can console themselves with the thought that, hey, Aristole didn’t figure this out, either.
Hood is president of the John Locke Foundation and publisher of Carolina Journal.