IT IS ALL A MATTER OF PRICE

That morning I learned how markets set prices. Imagine you just bought a painting at an art auction. You were willing to pay $20,000 but end up paying $12,300 instead. Who determined the price?

If you think you did, you would be wrong.

The only price you set was the most you would pay. You bought the painting because when the auctioneer said, “$12,200” someone touched his nose, and when he said, “$12,300” you pulled on your ear. At “$12,400” nobody moved – and you became the new owner.

Likewise, if you have something to sell, like a house, or your labor, you only set the least amount of money you would accept. When prices drop, home owners whine that they can’t sell their house. That’s not true. They just do not want to drop the price enough.

The Great Depression was caused, in part, by unemployed laborers. Prices dropped rapidly by 27% which meant that producers could not earn a profit unless they cut expenses by the same amount. But labor refused to lower their price enough.

Had everyone cut their pay by 25%, they would have had a 2% increase in real dollars. But they didn’t. Instead, they stopped working at any wage, and because they could no longer buy stuff, even for a 27% discount, the economy spiraled downward. (Economists call this kind of irrational thinking the Money Illusion.)

There is another factor at work… and that is the cost of doing something. We are not talking about what people normally think of, but rather a different kind of cost that is mentioned in the first week of Economics 101 and then never discussed again.

If you don’t know what I’m talking about, don’t worry; economists don’t know what they are talking about either.

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