Imagine that a generic drug becomes available for the treatment of a condition, no substitute good is available (inslulin might be a good example), and the elasticity of demand is low .Say that there are multiple companies producing this drug and competing with each other for customers.
Assuming no real differences in quality, competition should surely bring the price down to the level at which profits are around zero. So why do Austrians talk of prices being purely about preferences? Obviously a commodity won't sell if it isn't wanted, but that is just stating the obvious. What insight does this statement provide?
Consumariat:I don't want to abandon another thread, and for that reason I will make one point which I believe sums up the position of mine that seems to be the root of out disagreements. If anyone specifically needs me to respond to their previous questions then let me know and I will attempt to do so, but hopefully this post will make things clearer (either in where I am misunderstanding yourselves, or where you are misunderstanding me)
First, I want to make sure you caught my last direct response to you, here...(It ended up being the very last post on that page and someone came in and posted right after it so you may have missed it)
Consumariat:What I believe to be the issue of conflict is this; I maintain that price determines the amount of demanders - at any given price there will be a certain amount of people demanding that good (nothing controversial so far). But it appears to me that Austrians are saying that the amount of demanders determines the price. This is absurd. It's like saying that because the score of a football game determines who the winner is, we can find out the score of a game simply at looking at who won.
Be sure to read through that response I linked above, but look at it this way:
If you offered to sell a widget ... and decided since it cost you $25 to produce, you would set your price at $50 ...What if no one bought at that price? Most producers in that situation would lower their price. What if someone came up to you and said "I'll buy that widget for $40" and you decided to take the deal. What determined the price?
But if you could know the resources available, and if you had everyones set of preferences and expectations then you would be able to arive at the price solution.
This is the sort of thing I would find convincing. Could you direct me to a place where a model demonstrates this to be possible?
Also, visit this topic. The quoting system became broken a while back, but you can manually fix it each time. It will make your posts much more readable:
http://mises.org/Community/forums/t/18184.aspx
Here is the Salerno speech I mentioned (on Preference/Value Scales), he starts talking about them around the 36 minute mark, but I would recommend watching the entire speech:
http://mises.org/media/4486/Scarcity-Choice-and-Value
Consumariat:But if you could know the resources available, and if you had everyones set of preferences and expectations then you would be able to arive at the price solution. This is the sort of thing I would find convincing. Could you direct me to a place where a model demonstrates this to be possible?
Abskebabs already posted this: https://mises.org/pdf/asc/2002/asc8-Reisman1.pdf
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
Title of this thread: "Why do Austrians say price is set by preference rather than production cost?"
Answer:
(I seriously just came across this)
I think the main problem is linear causation.
Stimuly do not cause responses in people. People are not pieces of iron. If you heat iron (stimulus) you get lengthening (response) EVERY TIME. If you apply heat to a human beeing you don't know what specificaly to expect, but the end result will be the person trying to keep his temperature at 37 dg celsius. He might take off his shirt, he might eat an icecream, turn on a fan or jump in cold water.
You can never know what he will do, but only what his purpose is.
In exchange, anyone's purpose might be not to lose money or to profit. The price someone sets might be a result of calculating costs, might be a result of calucating how much other people are willing to pay, might be any abstract formula, doesn't matter. The only cause of prices are the people who are selling.
One of the best examples I have read came from a Daily post during Christmas.
The example was one of those inflatable santa's that are oh-so-popular during that time of the year. A couple sees one and the wife decides she wants it. They are sold out of all the ones in the box, but they still have the display model. The couple is able to negotiate 10% off due to the fact that it was displayed.
This particular model, though, actually had the highest production cost of all of them. It took the time of a paid employee to set up the display, and then to set it down. More production cost, but lower price. All because of preference.
If noody had diabities(or if there were some other way to perminantly cure diabities), then insilin would be worthless, no matter how many people/firms were producing it....
These last couple of posts just completely misunderstand the point that I am making. As to the posts that came before that, I am reading through Bohm Bawerks essay and will respond soon. Cheers for directing me to it, its very interesting so far.
thobishop:One of the best examples I have read came from a Daily post during Christmas. The example was one of those inflatable santa's that are oh-so-popular during that time of the year. A couple sees one and the wife decides she wants it. They are sold out of all the ones in the box, but they still have the display model. The couple is able to negotiate 10% off due to the fact that it was displayed. This particular model, though, actually had the highest production cost of all of them. It took the time of a paid employee to set up the display, and then to set it down. More production cost, but lower price. All because of preference.
Oh you mean like this one?
Forgive me if I claim to much, but it seems as though you're also assuming that production cost can't/won't change either. The likely in such a scenario winner isn't one who can successfully sell their product above production costs, but the competitor that can produce their product at lower cost than their competitors can.
In such a competitive environment, the incentive to discover methods for lowering production costs would be paramount. A business with the capability to reduce production costs would likely keep their prices at market level and bank the profit unless they felt particularly aggressive and wished to out-bid everyone else whilst they had the edge.
So, while production cost is a lower limit, it is by no means static or unchangable. Just look at the industrial revolution. While I think I just gave an argument for production over preference, I would have to agree with the preference argument. Others here have supported it well enough I believe.
"So, while production cost is a lower limit, it is by no means static or unchangable"
This is it. This is exactly what I am claiming. Production cost is a lower limit, but it is a lower limit towards which prices gravitate. It is this gravitation that incentivises firms to innovate and produce at lower costs with new technology.
Consumariat:"So, while production cost is a lower limit, it is by no means static or unchangable" This is it. This is exactly what I am claiming. Production cost is a lower limit, but it is a lower limit towards which prices gravitate. It is this gravitation that incentivises firms to innovate and produce at lower costs with new technology.
Did you even read either of my posts responding to you? Or at least the article in which Prof. Salerno directly addresses your question exactly?
Production costs only contribute to price once competition has created an incentive to modify it though. Prices originate with preference. Consider:
No elixer of immortality exists, yet the demand for immortality exists. Regardless of the production cost, a preference of willingness to pay for it exists. A proper Nihilist sees no point in purchasing immortality, nor does a religous fellow awaiting other-wordly paradise.
Demand preceeds production. Thus, price is primarily established by preference. Even if some abstract, never before concieved product is invented by one creative fellow with a use concieved only by him or her--it's price can only be set by the preference of another willing to put it to use for it's stated reasons or otherwise.
Preference sets price because preference is an analog for desire. Desire always preceeds action. So while production costs are an important variable in the price function, they are wholly subservient to preference ultimately.
Consumariat:Production cost is a lower limit, but it is a lower limit towards which prices gravitate. It is this gravitation that incentivises firms to innovate and produce at lower costs with new technology.
Yes, this is just another way of saying Marginal Revenues tend towards Marginal Costs.
But just to reiterate, even those Production Costs are dependant on consumer preferences (see all of the previous posts/articles everyone has been pointing you towards).