When does the market get prices ‘right,’ according to consumers? To read the news or listen to broadcast media, one might think that the answer is ‘pretty much never.’ People just aren’t happy with prices as a rule, of everything from gasoline to groceries. Yet it’s not true that markets generally get prices wrong, in spite of the fact that we consumers think we know better. And though the noise level rises as prices rise, there’s very little hurrah when prices descend. Even though the highly reported price of gasoline has fallen lately, a Google search for falling gasoline prices brought up few articles, none from the current calendar year, and most at least three to five years old. It’s as if we’re programmed not to notice (at least publicly) falling prices. If so it’s too bad, but worth paying attention to, at least now and again.
That we pay more vocal attention to the painful changes in our daily lives, and seemingly take good events for granted may be part of human nature. But if we’re going to pay attention to market prices only when they rise, we are going to miss half of the important story of what prices do for us, day in and day out, every day.
I have already extolled both the virtues and problems of rising prices in other Free Market Minutes. I’ve argued that they play a critical role in getting us to conserve when prices are rising. That conservative reaction is extremely helpful in allocating existing supplies—no mater what the reason for the rising prices.
What would we have to say, though, to suggest the need for more vocal recognition of falling prices in the market place? Falling prices are more than just an obvious sigh of relief for consumers. Falling prices also change people’s effective incomes, and for the better. So why are fewer headlines and news broadcasts proclaiming falling prices (they do and are happening, even in gasoline and energy) as leading news items? In fact, Wal-Mart pays big money for TV ads to make you aware of falling prices in their stores, on the assumption that you may not be paying attention otherwise.
We really should take falling prices at least as seriously as price increases, I would argue, because they tell us that something worth notice is happening in the market. Falling prices deserve a nod because they tell us that the patterns of market opportunities that face us, for whatever reason—and it could be due to ‘free’ market or regulatory causes—are somehow shifting. If it didn’t affect our behavior and ability to function in the economy, perhaps it wouldn’t be noteworthy. But that’s not the case.
Falling prices mean that sellers of goods are receiving less than before for the items and services they offer in the market. In some cases, purchaser’s prices as well as the seller’s revenue may both be falling—but don’t’ be so sure. Lower prices appeal to potential customers in different ways. Sometimes a ‘sale’ price results in benefits for the consumer along with greater income for the seller.
Lower prices can inspire purchasers to buy, rent, or hire in much larger quantities than before, meaning they come out ahead precisely due to the lower price. Price responsiveness from consumers suggests that in all kinds of markets—wage, rental, and goods—cutting price can make as much sense as raising it, if one’s goal is to increase employment, resource utilization, or profits. It’s an empirical test as to whether a price hike or a discount is the most sensible economic decision in any particular setting.
Significantly, falling prices (for even a few items or resources) open up purchasing opportunities that we didn’t have before, by making our money go farther. Our purchasing power is expanded, and everything whose price stayed the same is suddenly relatively more affordable. It’s as if those things were suddenly cheaper themselves.
The trouble with appreciating the importance of this relative price change is not that we don’t notice having extra cash to spend when one item dips in price. The problem is that our list of possible wants is unlimited, really known only to us, and may not even be part of our conscious or articulate knowledge.
Few of us, in other words, make out an explicit list of things we will do or purchase in the event that different amounts of income are freed-up. The difference between choices with an extra dollar we now have due to lower prices, versus an extra few hundred dollars, is significant. What we do know is that we will surely think of some as-yet-unfulfilled want(s) that will match the money saved on purchases of lower-priced goods. If I save $2.00 on coffee, I know I can take advantage of another opportunity somewhere, even if I can’t name it right now—it may be inarticulate before I encounter the opportunity to use it elsewhere. I will only know for sure after the fact what course I decided to pursue.
That’s really why we seem so much more sensitive to rising prices than to falling ones, I suspect. When prices rise, we know in advance what we are missing out on, what our opportunity costs are. If gasoline rises to $3.75/gallon, the lost purchases in terms of other goods appear fairly concrete to many people, whereas a drop in price of .50/gallon takes time to appreciate. A loss of something known is always more sensational than a gain of some thing or things we cannot name. And we haven’t always worked out in advance what we can do with the extra spending power.
So when do producers, sellers, and markets get the price just right? If regulations and other policies don’t force prices up or down capriciously, prices should be more or less right most of the time. It is generally true that consumers would, if wishful thinking could prevail, determine that everything except their own labor and resources be supplied for free. Suppliers would prefer that prices be limitless (except of course for the resources that they purchase).
The upcoming birthday anniversary of Nobel laureate Milton Friedman gives us a chance to emphasize once more the critical role of price changes. Prices and price changes serve the vital function of coordinating people’s choices and plans, both buyers and sellers, whatever they are.
Since all of us are simultaneously buyers and sellers, as long as prices are flexible and free of undue interference, they will be generally be pretty close to ‘right.’ And when the price is right, we all tend to win.