The Price of Everything

            The housing market. Health care. The stock market. Gasoline. Probably one of these things has caused you or someone you know some stress recently. And why is that? Prices. Prices for houses are too low for some home owners, which means they are losing equity. Prices for health care are too high for the procedures some people want or need. The prices for stocks are too low for my 401(k) to be worth what it used to be, and the price of gas is too high for me to not wince when I go to the pump. Everyone at some point pays attention to the price of something. So what does it all mean?

            Despite all the ecstasy and misery they can cause, and everything people want them to be, prices are just pieces of information, and specifically information on how much people value certain things. Certain folks feel that prices are encroaching on too many aspects of life. This is somewhat inaccurate. What they are really missing is the idea that certain things were “free”. The concept of “free” is something we’ll discuss a little later. For now, we’ll leave it with the maxim of Milton Friedman: “There’s no such thing as a free lunch.”

            But back to prices as information. The biggest achievement that market economies have is to have a known amount on what a certain product or service is worth to the general population. We’re essentially competing in every commercial transaction we take part in. I would like to but a cup of Starbucks coffee for a nickel, but enough other customers are willing to pay more for the bountiful but still limited supply of coffee that they have. So I’ll pay what everyone else is paying. Starbucks is taking a chance by pricing their coffee where they do, because a Caribou Coffee can open up across the street and charge a little less. The price of a cup of coffee is a conversation between the various buyers and sellers over what everyone’s time, effort, and enjoyment is worth. And because it’s a conversation, prices are also a negotiation.

            The negotiation is the stressful side of prices. Take gas prices. Right now, Americans are facing a time when they don’t have the same negotiating power that they had in previous years. Oil prices have gone up, and as we purchase comparably the same amount of gas (perhaps a little less than before, but not enough to lower the price), we communicate that we are accepting the new price. Some internet letters fluctuate trying to get people to act in unison to “show” the gas companies that we don’t need them. The fact that people are trying to organize that sort of boycott, though, shows that we do need them. We have reached a point where we aren’t happy about the prices, but we keep purchasing it. This is described as economists as inelastic demand. As the price goes up, demand doesn’t drop much. Now if it went up enough, people would have to explore different options, as people would be completely priced out of the market.

            This negotiation is also seen in the housing market. Prices a few years ago were on the ascent. People were receiving money on easy terms from banks. The price of the loan money came at a low introductory rate, which increased later. People weren’t worried about this, because the increase was offset by the increase people expected to see in the worth of their house, which is the price someone would pay at a later date. So why was a drop all of a sudden? People talk about the ebb and flow of the market, but again, that is only the communication and negotiation of different buyers and sellers. At a certain point, the overall opinion of the crop of buyers and sellers was that the worth of the houses was lower than it was in previous months. That could be due to a number of things, but largely it can be seen as an effect of people reaching the max of both what they can afford and what they expect people will pay.

            So how do home prices differ from gas prices? Gas prices keep going up, and people keep paying for more gas. But home prices kept going up, and then they started going down. The correction is a little easier to understand when considering the size of each purchase, and more importantly, the number of purchases. Gas is purchased by millions of Americans every day. Every purchase is a “yes” to the price offered. Houses prices, too, are “yeses” when they are accepted. But the yeses can be harder to come by here. A yes to a home price involves many steps involving multiple parties. The conversation is much slower. People were forecasting a bubble in the housing market, and they were doing this because they knew people were counting on the future conversation to go in the same direction it was headed. People purchasing near the peak had started the buying conversation probably months earlier. They had become committed already to purchasing. However, at the same time that was happening, people were in the position to decide whether or not to embark into the market. At a certain point, more people decided to wait. The pricing conversation wasn’t enticing for them. They started saying “no”. It turned into a waiting game, with sellers also saying
“no” to lower offers. This conversation is ongoing, with no clear general agreed upon end point.

            How can people use the idea of pricing? Clearly, it’s a good estimate on what is considered valuable. Back to the people who didn’t like things to have prices. Can you put a price on time? Or health? Or clean air? Well, actually you can. Any of these things involves a trade off, and that trade off is price. People’s time is worth their wages or salary, or at least what their earning without having to put forth the effort of finding something new. Health? People want to be healthy, but there is a cost in sacrificing things you might want to eat, or time spent exercising when you’d rather be doing something else. And that’s the problem with “free” and why nothing really is free. If everyone has access to something, they will use up what is valuable in the first place. Price is used to distinguish how valuable something is, so that the right number of people have access to it, and this is done by those people giving up something else (usually time in the form of work).

            An upcoming article will look at prices in other aspects of our lives, where money doesn’t necessarily change hands at all.