[2912] Wisdom is knowing when prices failed

There are discussions — or rather venom exchanges as it goes on social media these days — about prices and price control of certain items. I think I am here to highlight the obvious because oftentimes the obvious is overlooked due to familiarity: prices are only a method of allocation out for many out there.

There are other various methods in our toolbox if we care to learn.

Prices as an efficient allocator of resources

Now, prices are usually the best (efficient) allocator of goods and services in a society under normal circumstances. The thing with prices is that it is a reflection of the underlying demand, supply, and the context those demand and supply. Prices encapsulate all the necessary information needed to allocate resources. And under normal circumstances, that is good enough to allocate resources efficiently.

“Normal circumstances” is a catch-all cheat phrase. It almost always includes the assumption of (near) competitive/efficient market. Efficiency needs to be defined further: net increase in societal welfare. If it leads to a net decrease, the efficiency argument would melt away, and so too the merit of prices. Never mind prices, in theory, are not the only way to clear the market.

I make it sounds as if the price assumptions are a set of flimsy conditions. They are not. They are quite robust and hard to break, really. More than that after the section immediately below. The point is, it takes an extraordinary circumstance for it to happen.

When prices failed

During a war for instance with staple items suffering from massive supply disruption, prices will shoot up to an astronomical level. It is unclear prices will be the best means of allocating resources in this case if it would lead to a majority dying out of hunger due to unaffordability instead of absence of food, or protection gears. Even more so when a panic strikes, and hoarding takes place. After all, prices are only a means to a end. We care a whole lot more than prices. We care about our welfare.

This is mainsteam economics: most people do learn about market failures, that is when market mechanism decreases societal net welfare due to private cost failing to account for public cost.

Augmenting prices

When prices failed, it does not mean prices as a whole failed. There are various designs available to counter such failure before prices become completely irrelevant to welfare concerns. We can do price discrimination for instance, even all the way to first degree if we have the technology. We can impose quota within price mechanism. We have taxes and subsidies, an even that could be handled through tax and subsidy discrimination. We can impose coupon within price mechanism for instance. There are price ceiling and floor. We can be creative within market mechanism.

Do not forget these truths: we know when market mechanism is superior, and when it is not. And there are degrees of failure. Do not let your politics blinds you to it.

Knowledge and wisdom

Knowledge is about knowing the tools of allocation available and all of its possible combinations. Wisdom is knowing which tool and its combinations are useful during which period. In the case of prices, wisdom is knowing instances of market failures and which tools are available to address it. Prices are not superior all the times. Remember its assumptions.

Now, we have a crisis on our hands and it is affecting some items in the market. Some items are more important than others. We have the tools. Perhaps we need to relearn our lesson and develop some wisdom.

This is especially so when we are so partial to a method of allocation that we forget the assumptions why it works in the first place. We cannot imagine that those assumptions can breakdown.

This failure of imagination is perhaps a flaw in our classrooms. We take for granted these assumptions for pedagogic reason at the entry level in economics classes. It is worse when it done thru rote learning. And these weaknesses form the basis of popeconomics that is sorely inadequate to address our supply-side crisis.

By Hafiz Noor Shams

For more about me, please read this.

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