In July, rioters laid siege to several Pakistani stock exchanges to protest declining prices in the stock market. At the Karachi Stock Exchange, a mob of small investors destroyed equipment and files, smashed windows, and burned tires in a rage over falling prices.
In a similarly-themed if less violent protest, two little girls in Utah, upset that their parents could no longer afford cable television due to increased gas prices, recently marched around downtown Salt Lake City with signs protesting the price of gas. One girl explained, “Gas prices are too high. I just decided to come and protest so they’d go down.” Most would agree that this is a childish way to attempt to change prices, yet many adults share the basic idea on which the protest is based.
Both the Pakistani rioters’ and the girls’ protests are rooted in the idea that the market, and in particular, prices, are arbitrary. They believe that stock exchange executives or foreign investors or the oil companies set prices to any level they choose—and that therefore, the effective response to rising or falling prices is simply to demand that someone change the prices back to the desired higher or lower level.
This view of prices—that producers can set whatever prices they wish without consequence—is fundamentally mistaken. If producers could really set prices per their whims, why did oil companies wait so long to start selling oil at $100+ a barrel? Why, only a few years ago, did they choose to sell oil at less than $20 a barrel rather than rake in the profits at a higher price? If businesses can name their prices, what explains the steady decline of prices of goods like computers, cell phones, and flat screen televisions—even as these devices are sold with ever-greater capacities and improved features? The (inflation-adjusted) prices of virtually all material goods have gone down, not up, over time. If businesses could arbitrarily set prices, why would prices ever go down?
The answers to these questions can be found in any basic economics textbook. While producers seek to get the highest possible price for their goods, consumers want to pay as little as possible for the goods they buy, and the market price is some equilibrium state resulting from the two competing pressures. Producers supply goods and consumers, offering their own wealth in exchange, generate demand for goods; absent government intervention, price is a product of the two. This is the law of supply and demand, the fundamental principle of economics. Many factors affect the quantity and type of goods producers supply and the quantity and types of goods consumers buy, and all these variables are integrated into one unit: the price. In a free market, prices are based on the interaction of supply and demand, which themselves are based on individual judgments and values, not on executive caprice. Prices are not subjective.
Prices will change as supply and demand change. The first portable cassette tape players in the 1970s, for example, sold for about $1000, but as technology made such products easier to supply and as the ready availability of more sophisticated portable music players has reduced the demand, the price has decreased. (Much-improved portable cassette players now retail for less than $40.)
Prices in turn modulate supply and demand over time. Producers will leave industries where the prices are too low to make a profit and sell products in fields where prices and profits are higher. Consumers will generally buy less of a product, either economizing or looking for another supplier or an alternate product, the more prices increase. This dynamic is one reason that the sales of French wine have dropped in recent years as vineyards in the U.S., Australia, and South America have continually produced more fine wine at lower prices. It is also why more people buy portable music players now than when the $1000 portable cassette player debuted.
Keeping in mind the effect prices have on demand for a product, consider what would happen to businesses that set their prices above market prices. What if Sony tried to sell its portable cassette players for $1000 today? It would lose business to or even be run out of business by its competitors. In a free market, companies that want to remain in business long must set their prices according to the market.
In short, market factors determine prices; this is something that both sets of protestors fail to realize. Unfortunately, children and violent mobs are not the only ones who are ignorant of or disregard how the market functions. Some American voters share their ignorance, and worse, expect their political representatives to enforce their bargain price demands. Many voters expect the next president to bring gas prices down—either by directly regulating prices or by threatening the oil companies with higher taxes on their profits, nationalization, etc., to get them to lower prices.And the candidates are responding. A key component of Barack Obama’s energy plan involves mandating that oil companies “rebate” some of their “windfall profits,” and John McCain speaks arrogantly of how he will “take on” big oil.
Unlike private citizens, the government is not limited to inanely protesting prices—it can force companies to set prices according to the voting public’s caprice. For those who have no moral qualms about, in effect, taking over someone else’s business via government proxy, doesn’t it make practical sense to simply demand, like the rioters in Pakistan, that the government disregard market prices and mandate the price one prefers?
In fact, this is exactly what happened during the last world gas price crisis in the 1970s—Nixon attempted to “fix” gasoline prices by mandating lower-than-market prices for oil. To understand the results of this policy, remember that higher-than-market prices (what we would have if Sony tried to sell cassette players for $1000 today) reduce demand. Lower-than-market prices have the expected and opposite effect—they increase demand. Nixon’s gas price caps resulted in artificially higher-than-market demand that outstripped existing supplies. This brought about shortages and long lines at the gas pump.
Jimmy Carter replaced the price caps with a windfall profit tax of the sort both Republicans and Democrats are now clamoring to place on domestic producers. Both policies, by artificially capping prices and/or profits below market levels, reduced supply by reducing incentives for domestic producers to spend money seeking new sources of oil or developing technologies to increase oil supplies. At the same time, new environmental regulations on drilling and refineries further constrained the domestic supply of oil. By the time the windfall profit tax was finally repealed in the late 1980s, domestic oil production was at its lowest level in 20 years.
Supply and demand set market prices, and just as a business cannot long prosper by keeping its prices above market rates, an industry cannot long prosper when the government forces it to set prices below the market rates, no matter how stridently consumers demand such prices.
For all of these reasons, blindly protesting prices is futile and leads to worse-than-futile destructive government policy. Those who are truly concerned about oil prices would do far better to protest government involvement in setting prices, slashing profits, and regulating the industry to death than to demand, once again, that the government magically make their bargain shopping dreams come true.