THE THEORY OF PRICE 2

By M. Northrup Buechner

January 23, 2013

Another in a series of essays elaborating Objective Economics: How Ayn Rand’s Philosophy Changes Everything about Economics by the author.

 

Let us approach the material from my last blog from a different direction.

The starting point for every individual businessman, the primary value he is pursuing, is the survival of his business. This is obvious for the new owner of a dry-cleaner. A business faces the alternative of life or death just as every living creature does. If a business fails in this struggle, it goes bankrupt, which ends its existence.

A businessman whose firm is large and successful and growing may not worry about survival, but that does not change the fact that the possibility of failure underlies every economic action. Large, successful, growing firms have gone bankrupt. Running a business is not a game.

The basic requirement for the survival of a business is profit. If its revenues exceed its costs, a business can go on forever. If its costs exceed its revenues, the business’s days are numbered unless that condition can be reversed.

The basic requirement for profit is sales. The expectation of sales is a prerequisite for production in a market economy, unless the producer does not intend to sell his product (which sometimes is the case). A business’s sales are measured by the price charged times the number of units sold at that price, for every product the business produces at every price it charges. The summation of the value of every sale is the businessman’s total revenue.

Sales are an expression of demand. Demand is the average quantity the businessman sells per month at the price he selects. Demand is a measure of how urgently customers want the businessman’s product as measured by the prices they will pay and the quantity they will buy. Part of the businessman’s job is to determine the price that most accurately measures this urgency.

Every price originates in the grasp of economic facts by an individual human mind. In other words,  every price is objective in the exact sense defined by Ayn Rand. The underlying principle is that prices are based on facts—prices reflect facts—prices originate in facts. In a free economy, businessmen set prices that reflect the facts of their markets, because they want to stay in business.

In addition, competition often has a major effect on demand. In extreme cases, the price and quality offered by competing firms can put an inferior competitor out of business. Short of that, a competitive context is created by the price and quality of product of all the firms in the market offering that product. For the individual firm, this context is an absolute of which the firm must take account when changing its price.

Further, when a business changes its price, it changes the competitive context for all the other firms in its market, who now have to decide how to deal with that change. This means that the firm changing its price may have to anticipate how its competitors will react to that change. A competitive context is one in which such changes and counter changes in price can occur.

In choosing a price, the businessman integrates the joint effect on the quantity he can sell of both the price he charges and the competitive context, plus any other facts he considers relevant. Such a price constitutes the objective economic value of the product—“objective” because it reflects the best rational judgment of the price setter. We know it is his best rational judgment because his business’s survival is at stake.

A price that is the product of such a process measures the “willingness to pay” of the company’s customers. It reflects how urgently customers want the company’s product as measured by the price they are willing to pay. This is the meaning of economic value. This is what a price measures, as distinct from aesthetic value or philosophical value or political value or any other kind of value. Economic value is money value, the sum of money (the price) that people are willing to pay—with one additional proviso. They must be willing to pay a price that is high enough and in sufficient numbers to cover the business’s costs.

COSTS! That is the third cause of price with which the businessman has to contend if he wants to stay in business.