Sunday, June 17, 2012

The Signal That Motivates

‘Six meat pies for 10 dollars’, noted my partner while we were driving in Newcastle, New South Wales recently. He had read it on a sign and I replied that it was a great deal. This seemingly insignificant event got me thinking about why it seemed cheap. Nothing about meat pies as such would provide a clue (and especially not for those of you who live outside Australia), but something does provide the context for knowing how to declare whether something is cheap or expensive. That something is the price system.
Now, if you visit a pie shop in Australia, you will likely pay four or five dollars per pie. Therefore, six for 10 dollars is indeed inexpensive by comparison. None of this is interesting in isolation from the entire network of prices we live with every day. If you pause to consider how prices motivate a great number of your choices in life, it is instructive to think about how you would live if there were no prices.
A story from my year teaching English in Slovakia provides just such a backdrop for what happens when prices are eliminated from daily life. A Slovak friend discussed with me on a number of occasions how he would run a bread kiosk on the main street in Prešov. For starters, he would not charge the same prices as the other kiosks because none of them made any money. My friend had spent a certain amount of time in the US and therefore ‘knew’ how the capitalist system worked. He would charge at least twice what the other bread vendors did.
‘Would you sell the same bread?’ I asked.
‘Of course! Why would I trouble myself with different bread when I know what kind people like to buy’.
‘Then why would you charge so much more?’
‘Because I want to make money!’
‘But how will you persuade people your bread is worth twice the amount they can pay elsewhere?’
‘I don’t need to. They will know that my bread is better because it is more expensive’.
‘But if it is exactly the same bread, why would people buy yours? Wouldn’t people think you’re just ripping them off so you can make a quick buck?’
‘People are not smart enough to know this!’
This exchange brought home to me the idea that it is not an individual business that sets prices in isolation from all other businesses. Indeed, the price one charges for anything must reflect what people are willing to spend based on their values and incomes. Therefore, if a loaf of bread in Slovakia typically cost the equivalent of 50 cents, charging a dollar would not motivate a buyer to change vendors - or not for long.
I did not fault my friend for his faulty reasoning. After all, he had grown up in a socialist country where prices did not exist and thus he had never learnt their function. To him, a price was an arbitrary figure to be chosen at whim. Additionally, the habit of comparison shopping was only beginning to take hold.
I spent months discussing the western system to him, even though I myself was far from an expert on the subject. I based my knowledge not on theoretical study but on decades of living in freer countries. I knew what an average loaf of bread cost in various countries and I also knew that a more expensive loaf cost more because of better or specialised ingredients. And so it went for everything from cars to stereos to bicycles. I realised over time that prices are how people make the simplest decisions about how to conduct their lives. Will I go out for dinner Friday night with my friends to the hot new cafe in Sydney? I’d better check their menu online and decide if it’s worth the cost, versus staying home and cooking. Will I spend the weekend away with my partner or will we stay home and do something locally, instead? A check of hotel and restaurant prices will determine our choice to go away or not.
Now consider the resulting chaos if no price system existed, as I experienced in Slovakia. What if, instead of individual buyers and sellers setting prices constantly, we had elected officials decreeing what things ‘should’ cost, and not just for the things some of us think of as ‘free’, but everything. To those of us brought up in the semi-free nations of the western world, we would quickly find out what life was like under the Soviet bloc dictatorships. I found out myself what that system did to people on a daily basis. Since then, I have made myself the solemn promise that I would never take my freedom for granted again.
Since returning to the west nearly two decades ago, I’ve spent years learning about history and economics. From my studies, I have concluded that I revere prices in the same way I am devoted to my loved ones: they reflect the rational choices we all make to ensure our lives are better and happier.

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