The Economic Answer to a business "Taking Profits off the Top"

Economics Economics Questions
1

My friend and I were having a conversation about businesses, relative to making profits. His viewpoint was that companies can increase profits buy just “charging more”. Private Insurance Companies was the example, although it applies to most. His view was that they just tack on more money to increase the profit margins. I thought that would only lead to the company going under, because the competitors would be a better deal. He felt because of human greed, they all do it. What is the Austrian “remedy” to price fixing? (Assuming his theory is accurate)

I argued more competitors…am I correct or wrong, or is this more of a government justice issue?

P.S. Im an Austrian Newb :slight_smile:

2

I am an newb as well, but I think the invisible hand of the market will act against such price fixing.

3

If your friend’s theory is correct, why isn’t he starting businesses like mad?

4

Greed is a non-sequitur.

What stops companies from having lower prices and thereby attracting more consumers (more profit), especially consumers that had low ordinal ranking for insurance, ie. low value for insurance. If you need to add “because they’re greedy” so be it, but greed isn’t necessary to describe what’s happening as it could be used in both descriptions it would seem.

5

I believe price fixing is a form of fraud

6

So if Nike charges $2000 per shoe, are their profits going to increase?

7

Ask him why Wal-Mart doesn’t charge $1000 for milk.

8

Really? Why?

9

Marginalism. Increasing the price of a good will reduce the demand for that good and thus result in a smaller income for the seller, who may realize losses because of his excess production and supply.

10

I wrote a paper on the Communist Manifesto and wrote a section on this supposed problem of the capitalist skimming profits off the top.

"Marx points out something very interesting. He points out that the worker always gets paid less than what he actually produces. If a worker produces 1000 toys in a week, he might only get enough money to buy 400 of them when he receives his paycheck on Friday. Marx argues that this is exploitation; the worker creates the product and the capitalist, who does no work on the product, skims some profit off of the top for himself.

In this analysis, Marx leaves out one incredibly vital component of all voluntary interaction: time. The worker is willing to take the job, because he would rather gain goods now than in the future. Imagine a man is hoping to get a car for his family. He could go out and mine the ore needed, meld it himself, create an engine, and create all the necessary parts for the car. He would gain 100% of what he produced, because he is working for himself alone. This would take him an extraordinary amount of time to do, though. He wants the car sooner rather than later. Because of this he is willing to work a job to earn money with which he can buy a car much sooner than he could ever make one himself. He is willing to allow the capitalist take a portion of his product in return for getting his car sooner.

Let’s look at this same story from the capitalist’s point of view. He has a wealth of resources, both in capital goods (factories and tools) and in cash, which he hopes to increase into more wealth. He is willing to pay the worker $100 now in return for higher profits in the future. If he could not skim some profit off of the top, he would have no incentive to hire the worker and the worker would have to spend much more time and energy to get the car he wants. What’s the point of paying $100 out today in return for $100 in a year? Why not just hold onto it then?

As we can see in this thought experiment, the capitalist and the worker are not at war with each other. They are not hoping to achieve contradictory goals. Their purposes are harmonious and only the free market will allow them to come together to achieve their subjective goals. Dr. Hoppe explains it concisely and precisely:

Without the capitalist’s expectation of an interest return, the laborer would be worse off, having to wait longer than he wishes to wait. And without the laborer’s preference for present goods, the capitalist would be worse off, having to resort to less-roundabout and less-efficient production methods than those which he desires to adopt."

Hope that helps. Those who claim this as a problem of the capitalist economy completely ignore time preference and marginal valuation.

11

We can nevermind that what your friend suggests doesn’t really happen. To put it simply, one can see profit in not charging the same inflated price as a competitor. Charley charges 55 cents for a pint of milk, but Nancy charges 45. The reason Nancy stands to not only drive away competitors, but make larger profits, is because not only are people buying the cheaper milk, but more people are buying it. There are those who, at 55 cents, were not willing to pay, but at 45 cents, the money lost becomes less important than the milk gained. There is also a great side-effect to this as well. Charley now has to either match or beat Nancy’s price to increase profits. He is losing customers at his price. This is what happened to prices at various supermarkets once Wal-mart hit town. I used to pay 2.19 for pot pies. Wal-mart began selling them at 49 cents, and now the same pot pies I bought at Meijers for 2.19 are 57 cents. Taking into account that Wal-mart is a longer drive than Meijers, I can choose to spend the extra eight cents and save on gas, benefiting from Wal-mart’s business model without actually patronizing them. This is precisely why competition is healthy.

12

Jonathan, this is off topic but I just have to say that when I was your age (18), I was a socialistic, naive, ignorant, arrogant fool. It required 20 years for me to learn what you have posted here. Those who are pessimistic about the future (like myself) need to remember that there are young people (like you and Josh) who understand capitalism, free markets, and freedom. It struck me that this is perhaps the genius of the Ron Paul Revolution: He did an end around the media and the “system” and went directly to millions of internet-connected young people.

Now, back to the topic…

13

Because you are basically lying to the consumer making him believe that there are two businesses competing with each other for lower prices when in reality its just one business in the practical sense of the word.

14

I don’t really get what you are talking about. It sounds pretty ridiculous. Can you give us a real world example?

15

Once again, I refer to one of my favorite resources for quick, digestible answers to these things, Jim Cox’s Concise Guide to Economics. If your friend is the reading type, direct him to http://conciseguidetoeconomics.com/

Here is his chapter on profit and loss.

16

Well of course, in my country Chile, more specifically in my city there are a small number of pharmaceuticals, recently it was discovered that all of them were colluded into raising prices, basically they all had agreed to keep prices high and were overcharging people on the price of essential drugs, Im talking heart pills and so on.

Now you may say competition would eliminate that oligopoly, but there arent any more pharmaceuticals here so basically what little competition those companies had, that was it.

People didnt know, they kept buying and sometimes they didnt have the money.

Now selling the idea of a free market is damn hard when you have cases like that, so if its not fraud, what is it?

17

There is the problem, pre-existing government regulations. I assume there are various tariffs and governmental barriers to entry into selling heart pills. All your example might prove is that where government gets involved in trade, economic destruction follows.

This doesn’t fit the typical use of the word “fraud”. In order to assign criminality to the pharma companies, you need to prove intent to wield government power in order to establish the monopoly. This may be true or not, possible or not. In many cases there is no intention on the part of corporations and they are merely participating in the economy self-defensively.

The only thing that makes such a simple concept a “hard sell” is people leaving out the element of government in the picture they paint and trying to denigrate free trade. There are plenty of examples of industries with at least relatively less regulation, for example computers, where technology constantly improves and prices for each level of technology constantly fall. Producing commonly used medications isn’t even close to as difficult as producing the next fastest processor.

18

Caveat emptor. Buyer beware.

An attempt to deceive is different from a deceipt, and to deceive is different from being deceived.

A seller offering you a price is a statement (expressed or implied) that says nothing more than “I wish to sell you such and such for such price”. Nowhere here do I see a lie about the nature or substance of the contract or the consideration for it. You have the option of refusing to contract. If you accept the price, you fully accept the consideration and performance of the contract on your part. If you do not accept, the contract is not executed and you don’t pay the price and he doesn’t deliver the product. If you offer a price, he can accept, or he can refuse completely as well.

Therefore, the price at which the sellers and the buyer buys is a price established at a meeting of minds and a proper consensus. You buying at the price is you accepting to want the product at that price, and the seller selling at the price is the seller accepting to sell at that price.

If a seller were to say that he was selling you a fertile cow, knowing full well it is sterile, and you had no means of finding out its fertility at the time, then you have been a victim of fraud. But a supposedly fixed price is no more than an offer that you have complete and full understanding of, and you have the discretion to act on out of your own ability to think.